A couple of years after I was out of college, I got my first credit card. They were tougher to come by in those days. Not like now when my unemployed pet poodle has his own line of credit.
The first month I racked up about $300 or so. When the bill came, there was each charge listed by vendor, with the total at the bottom. In the upper right-hand corner there was a box with a $ sign in it and a blank space beside it. Under this in bold letters it read: Minimum payment due: $10
I could hardly believe my eyes. I get to buy $300 worth of stuff and they only require me to pay them back $10 a month? And I can still buy more? Wow! This is awesome!
But still, in the back of my mind I could hear my father’s voice: “If it sounds too good to be true, it is.” Not “it could be” or “it might be.” It is.
Fortunately, my older sister was sitting nearby. She pointed out the fine print. The part about them planning to charge me 18% interest on the $290 they were hoping I’d let ride. What? Did these people think I was stupid!?
As a matter of fact they did. It was nothing personal. They think the same of all of us. And unfortunately all too frequently they’re not wrong.
Pause for a moment and take a look at the people around you, literally and figuratively.
What you’ll often see, if you scratch the surface just a bit, is an unquestioning acceptance of the single most dangerous obstacle to building wealth: Debt.
For marketers, it is a powerful tool. It allows them to sell their products and services far more easily, and for far more money, than if it didn’t exist.
Do you think the average cost of a new car would be pushing $32,000 without E-Z financing? Or that a college education would cost over $100,000 if it were not for readily available student loans? Think again.
Not surprisingly debt has been promoted as, and largely embraced as, a perfectly normal part of life.
Indeed, it is hard to argue that it has not become “normal.” As I write, here in the US Americans carry a total debt burden of ~12 Trillion dollars:
- ~8 Trillion in home mortgages.
- ~1 Trillion in student loans.
- ~3 Trillion in other consumer loans such as credit card debt and auto loans.
In the future, these numbers will undoubtedly be higher. And most disturbingly, almost no one you know will see this as a problem. In fact, most will see it as their ticket into the “good life.” But let’s be clear. This blog is about guiding you to financial independence. It is about buying your financial freedom. It is about helping you become wealthy and putting you in control of your financial destiny.
Look around at those people again. Most will never achieve this, and their acceptance of debt is the single biggest reason why.
If you intend to achieve financial freedom you are going to have to think differently. It starts by recognizing that debt should not be considered normal. It should be recognized as the vicious, pernicious destroyer of wealth-building potential it truly is. It has no place in your financial life.
If your lifestyle matches—or god forbid exceeds—your income you are no more than a gilded slave.
Carrying debt is as appealing as being covered with leeches, and has much the same effect. The idea that many, indeed most, people seem to happily cover themselves with debt is so beyond my understanding it is hard to imagine how, let alone why, the downsides would need be explained. But here are a few:
- Your lifestyle is diminished. Set aside any aspirations to financial freedom. Even if your goal is living the maximum consumer lifestyle, the more debt you carry the more of your income is devoured by interest payments. A (sometimes huge) portion of your income has already been spent.
- You are enslaved to whatever source of income you have. Your debt needs to be serviced. Your practical ability to make choices congruent with your values and long-term goals is seriously constrained.
- Your stress levels build. It feels as if you are being buried alive. The emotional and psychological effects of being saddled with debt are real and dangerous.
- You endure the same type of negative emotions experienced by any addict: Shame, guilt, loneliness, and above all, helplessness. The fact that it’s a prison of your own making makes it all the more difficult.
- Your options can become so narrowed and your stress levels so high, you risk turning to self-destructive patterns that only reinforce the dependence on spending. Drinking perhaps, or smoking. Or, ironically, shopping and still more spending. It’s a dangerous self-perpetuating cycle.
- Your debt tends to focus your attention exclusively on the past, present and future in the worst possible way. You become fixated on your past mistakes, your present pain and the disaster looming ahead.
- Your brain tends to shut down on the subject with the vague hope it will all resolve itself in some magical way and in the magical time of later. Living with debt becomes hardwired in your financial attitudes, habits and values.
Countless articles and books have been written about ridding yourself of debt. If after reading this post you feel you need more guidance and help, by all means embrace them. But be careful not to let the pursuit of the methods get in the way of the doing. The truth is, there is no easy way. But it is pretty simple.
Here’s what I’d do:
- Make a list of all your debts.
- Eliminate all non-essential spending, and I mean all of it.* Those routine $5 coffees, $20 dinners and $12 cocktails add up. This is what will free up the money you need to pour on the debt flames that are burning up your life. The more you pour the sooner you stop burning.
- Rank your debts by interest rate.
- Pay the minimum required on all your debts and then focus the rest of your available money on the one with the highest interest rate first.
- Once you’ve blown that one away, move on to the second highest and right on down the list.
- Once you’re done, send me a note and let me know. I’ll then be raising my glass in a kudos salute to you!
Here’s what I would not do:
- I would not pay a service to help. This only adds to your cost and such credit counseling services have no magic formulas or techniques to make this less painful. You, and only you, can do the work.
- I would not worry about trying to consolidate your loans into one place, not even for a lower interest rate. You are going to pay these puppies off fast and hard. Once they’re gone your interest rate will be Zero. That’s your goal, not merely taking your rate from 18% to 12%. Focus your time and attention there, rather than on exploring clever strategies.
- I would not pay off the smaller loans first for the psychological boost. I know this is a key part of at least one popular strategy, and if it makes you more likely to stay the course so be it. But as you’ve learned reading this Stock Series, I’m not a fan of such crutches. Better to “toughen up, cupcake” and adapt yourself and your attitudes to the numbers than to adapt the strategies to your psychological comfort levels.
In short, nothing fancy. Just do the work and get it done.
This is not going to be easy. Simple, yes. Easy, no.
It will require you to rather dramatically adjust your lifestyle and spending to free up the money you need to direct toward your debt.
It will require serious discipline to stay the course over the months, maybe years, it will take to eliminate your debt.
But here’s the good news, and…
…it really is awesomely good.
Once you’ve ingrained that lower spending lifestyle and made diverting the excess cash to your debt your path, you will have also created exactly the platform required to begin building your financial independence.
Once the debt is gone, you need only shift the money to investments.
Where once you had the satisfaction of watching your debt diminish, you’ll now have the joy of watching your wealth build.
Waste no time. Debt is a crisis that needs immediate attention. If you are currently in debt take out your sharpest knife and start scraping the little bloodsuckers off. Nothing else is more important.
Look again at those people around you. For most, debt is simply a part of life. But it doesn’t have to be for you.
You weren’t born to be a slave.
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A few cautionary words on “good debt.”
Occasionally you will hear the term “good debt.” Be very cautious when you do. Let’s briefly look at the three most common types.
Business loans.
Some (but not all) businesses routinely borrow money for any number of reasons: Acquiring assets, financing inventory and expansion to name a few. Used wisely, such debt can move a business forward and provide greater returns.
I include small scale investment real estate by individuals in this category.
But debt is always a dangerous tool and the history of commerce is littered with failed companies ruined by the debt they took on.
Astutely dealing with such debt is beyond the scope of this blog, other than to say those who use it successfully do so with great care.
Home mortgages.
Taking on a mortgage to buy a house is the classic definition of “good debt.” But don’t be so sure.
The easy availability of mortgage loans tempts far too many into buying houses they don’t need or that are far more expensive than prudent. Shamefully, this overspending is often encouraged by real estate agents and mortgage brokers.
If your goal is financial independence, it is also to hold as little debt as possible. This means you’ll seek the least house to meet your needs rather than the most house you can technically afford.
Remember, the more house you buy the greater its cost. Not just in higher mortgage payments, but also in higher real estate taxes, utilities, maintenance and repairs, landscaping, remodeling, furnishing and opportunity costs on the money tied up as you build equity. To name a few.
Houses are an expensive indulgence, not an investment. That’s ok if and when the time for such an indulgence comes. I’ve owned them myself. But before letting yourself be blinded by the idea that owning one is necessary, always financially sound and automatically justifies taking on this “good debt,” run the numbers.
Student loans.
When I was in college at the University of Illinois from 1968-72, the total annual cost was $1,200. This $1,200 covered everything: Tuition, books, rent, food and even a little entertainment.
Each 12-week summer I worked taking down diseased Elm trees. I was paid $20 a day over a six-day week. I saved $100 a week and by fall had the $1,200 needed for the school year.
Of course, I lived in one room of a dilapidated old house that should have been condemned. White rice and ketchup served as dinner two or three times a week.
Fast-forward to 2010-14, my daughter’s college years. The all-in yearly cost averaged $40,000 at URI, also a state school. NYU, her other option, would have run $55,000 to $60,000 per year. As a former colleague of mine once said, that’s like buying a new BMW, driving it for a year and throwing it away. Then buying another. For four consecutive years.
Inflation certainly played a role. Using the CPI (consumer price index), what cost $1 in 1970 took $6.36 to buy in 2014. A six-fold increase.
In the same time period, a 4-year state school college education went from $4,800 to $160,000. A 33-fold increase.
Make no mistake: easily obtained student loans have flooded the system with money.
Universities have been and continue on a building boom. Fancier prices require fancier settings.
The average salary of a university president in 1970 was ~$25-30,000. Today it averages around $500,000 and can run into the millions.
Not only has this driven up the cost of everything college related, it has virtually eliminated the option of living cheaply.
That ramshackle house I lived in? Torn down to make way for fancy new dorms.
Eat in on rice and ketchup? No worries, my friends did the same. It was a source of pride. Today, it would be a source of embarrassment as all your student loan funded pals go out for sushi.
Moreover, one of the more unfortunate results of spiraling college costs and debt is the way it has warped the very concept of higher education. Rather than the pursuit of learning and culture, it has become the pursuit of job training in an effort to secure employment that will justify the astounding cost and debt incurred.
Even successfully applied, this shackles young people to jobs long after the appeal has faded. Youth should be spent exploring—building and expanding one’s horizons—not grinding away in chains.
Here’s the real kicker: Unlike other kinds of debt, as truly awful as they are…
you can never walk away from your student loans.
They survive bankruptcy. They will follow you to your grave. Your wages, and even Social Security, can be garnished to pay them.
No wonder banks are falling all over themselves to issue this debt.
I am a firm believer in personal responsibility and debts freely taken on should be faithfully repaid. But the ethics of encouraging 17 and 18-year-olds—who likely have little financial savvy—to almost automatically accept this burden gives me serious pause.
We are creating a generation of indentured servants. It’s hard to see the ethics or benefits in that.
Addendum I: While the mantra here is “avoid debt at all costs,” if you already have it, it is worth considering if paying it off ahead of schedule is the best use of your capital. In today’s low rate environment, here’s my rough guideline:
- Less than 3%, pay it off slowly
- 3-5%, whatever feels most comfortable
- More than 5%, pay it off ASAP
Addendum II: *Want to know what “Eliminate all non-essential spending, and I mean all of it” might look like?: If we woke up in debt
Addendum III: Some common sense on credit scores
Addendum IV: The College Conundrum
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Meanwhile and unrelated, recently…
- Responding to my post on Dollar Cost Averaging, Mike & Lauren explore the emotional side of the question in this video: What is your emotional threshold?
- Over on 1500 Days:
- On the Create My Independence Podcast: F-you Money, Stepping Away, Fear and Investing
