Funny about Money

The only thing necessary for the triumph of evil is for good men to do nothing. ―Edmund Burke

Smart Debt: Is there such a thing?

Influenced by Dave Ramsey, one of my honored students — maybe even a budding PF blogger, who knows? — writes on the horrors of debt. It’s pretty adorable stuff, in its lively and charming youth. The gist of his squib is that all debt is to be avoided, come Hell or high water.

There’s a lot to be said for that point of view. Matter of fact, our friend D. R. White (he of Motivating Minutes) has just published a new book on the topic: How to Get Out of Debt: Using the Internet. He includes the stories of fourteen PF bloggers (full disclosure: one of them is moi) plus ideas and tools to help you plot a course toward a debt-free life. He’s pretty proud of it…so now’s the time to run over to Amazon and grab your copy.

Reflecting on the student’s  jeremiad, though, it strikes me that true, full-blown debt-phobia entails a fundamental fallacy: it is not so that all debt is necessarily bad. What is bad is to get so deep in debt that should unforeseen circumstances occur (another recession or economic depression; illness; unemployment; whatEVER), you can’t make the payments.

Some kinds of debt are beneficial, though. For example, even though college tuition is now exorbitant, a typical young person with a bachelor’s degree will earn almost a million dollars, over a lifetime, more than a typical young person with a high-school diploma. Even after college loan debt and taxation are subtracted, the college graduate’s net gain amounts to hundreds of thousands of dollars.

The typical American college graduate  ends up with a relatively small student loan: about 30 grand. While that’s not pleasant, it’s actually about what a late-model car costs. Most people can pay off a car loan in five years. BUT the difference between a college loan and a car loan is that the college degree APPRECIATES over time (returning many thousands of dollars in enhanced earning power) while a car DEPRECIATES over time.

The college loan returns cash to the borrower and buys an asset that lasts a lifetime. The car loan takes money way from the borrower and leaves behind a devalued asset.

In effect, the college loan leverages debt to the borrower’s advantage. The car loan works to the borrower’s disadvantage. Thus one could argue that some kinds of debt actually benefit the borrower while other kinds work against him or her. The challenge is to identify what kinds of debt are worth taking on and what kinds represent a threat to your financial well being.

Similarly, a mortgage on a fairly priced house (not one whose value has been inflated during a “bubble”) may work to some people’s advantage. If you are earning money and investing it in a 401(k) or other type of fund, in an economy such as the one we’re in now, your investment returns about 9 percent. But today’s mortgage rates are still under 4 percent.

So, instead of paying off the mortgage, you’re better off to invest the amount in securities, which at this time are returning about 5% more than you would “gain” by throwing your money at the mortgage debt. Here, too, you leverage money to your advantage: you have to have a roof over your head, and the low-interest loan makes it possible to have your cake and eat it, too.

On the other hand, credit-card debt is usually disadvantageous, because most of it goes to buy material things that often are not needed at all. A television set, a closetful of clothing, a hundred dollars worth of fancy department-store make-up, a comic-book collection, a new computer game , a restaurant meal: none of these things appreciate in value or make it possible for you to build wealth. Thus this type of debt represents a drag on your financial well being.

These are important distinctions. They point to the fact that people need to have some financial sophistication to thrive in today’s extremely complex economy.

A loan that allows you to earn more or save more can be said to be “smart” debt. One that takes money out of your pocket and returns nothing of real value — well. Not so much.

🙂

Author: funny

This post may be a paid guest contribution.

20 Comments

  1. Nice, concise article on types of debt. What are your thoughts on taking on new debt for startup capital for a new business? I guess it comes down to the risk vs. reward formula.

  2. This new background is so much nicer. I was getting depressed with all that black.

    I LOVE debt. I put everything on a credit card, then pay it off before interest accrues. Love those airline points. Just came back from Europe, FIRST CLASS, because of them. Okay, it took me a couple of lifetimes to save up enough points, but what the heck, I still never pay any interest charges.

  3. I feel the same way about the beloved Costco AMEX card…it “gave” me $350 this spring! 😀 That, granted, is not even faintly comparable to a FIRST CLASS (!!!) trans-Atlantic ride. Zowie!

    But if you know you’re going to pay off the charges every month — because really they’re just the ordinary day-to-day cost of living bills that you have to pay anyway — is that really exactly “debt”? Apparently the credit bureaus think so, because they’ve assigned me some ridiculous credit rating even though I have no real job and I have no real income and I have no other debt.

    Glad you like the background. It’s lots more feminine, isn’t it? I’m figuring out how to get pix into that top thing and also how to get rid of some of the clutter. More decluttering to come!

  4. I was raised to avoid debt – my parents paid off their mortgage on their first house in 11 months, and never had a mortgage again. They never had car loans (my dad is a mechanic) and never held credit card debt.

    I was lucky enough to get my Bachelor’s degree without going into debt – a combination of help from my mom, and working while going to school. But after graduating and working for a year or so, I went back to school – a 9 month program, that cost $26,000 up front – which I did not have.

    So I signed up for the loan – took a year’s leave of absence from my job – and went back to school. The plan was that I could take the 9 months to do the course, then I had 3 months to find a new job using what I learned. And if for some reason I didn’t get a new job – I could go back to my (crappy) job and start paying off my loan.

    Thankfully, I had a job offer before I finished the course – so for the price of $26,000 student debt, I walked out of one job and into another at double the salary. And in the past 14 years, I’ve doubled it again. Paid back the loan in 3 years, and it was the best $26k I ever spent.

    Currently my debt is my mortgage and car loan (at zero percent interest). Yes, buying a brand new car isn’t an investment – but at zero percent interest, I have 5 years to hold on to the money I would have spent on the car, and put it to work in investments.

    • My parents behaved the same way! They would’ve hit it off with yours, obviously…

      My father didn’t buy a house — ever — until he had the cash to pay for it. They rented in the first years of their marriage; then lived in company housing when we went to Arabia, and then after we came back to the states rented apartments until he retired and bought the place in Sun City. Same with the cars: he paid cash. Period.

      State universities were fairly cheap in those days — I don’t think sending me to Tucson was much of a hardship for him. Today would be a whole ‘nother matter, though. Really, I don’t know how they would have afforded it. I probably would have had to take out loans or get a job to help send myself through college.

      My financial adviser also wants me to charge up a car at zero percent. Even though neither of us is thrilled at the prospect of shelling out money for wheels, whether in installments or in one swell foop, obviously it would be to my advantage to keep the money invested at 6 to 9 percent if no interest is charged on a loan.

  5. I struggle with this whole debt is bad movement. Not so long ago I rec’d a letter from a Bank I had done business with a while back. The letter wished me well and it seems they missed me. And due to my good credit standing offered me a 15 year mortgage at 2.625%….no points….no junk fees. It made me stop, think and consider the offer. I even called the gal to catch up and inquired about the offer and it was for real. Thought about it and talked it over with DW who gave it the “thumbs-down”. My thought was to refinance….take the cash…send it over to the folks at TIAA-CREF and let them work their magic. But I didn’t do it…despite knowing that “the best time to borrow money is when you don’t need it”….and wonder to this day if I did the right thing.
    Another struggle ahead is with the Amex card that I truly enjoy. I was paid $350 to take this card and the first year fee was waived. And the customer service is first rate as are the “rewards”. But now our buying habits have changed and that 6% back on groceries isn’t as important as it once was. And that $75 per year fee is harder and harder to swallow….

    • Borrowing money against the house so that you can invest it in the stock market…hmmm… Isn’t that what happened before the Great Depression? People borrowed on margin to buy stocks — what could happen, eh? When the market crashed, they lost their shirts.

      I’ve had the same thought. My house is now worth more than I paid for it, and it is paid off. If I borrowed one or two hundred grand against it, even at 4 percent I could turn several thousand dollars a year if the market keeps earning 8 or 8 percent. The “if” part’s a little too big for me, though.

      You know, AMEX does have a couple of no-fee cards: https://www.americanexpress.com/us/small-business/credit-cards/no-annual-fee

      I tried to take one out so one would be in place when Costco lets AMEX go, but because their underlings didn’t get their act together fast enough to do a credit check during the ten days I removed the freeze on my credit bureau accounts for them, I gave up on that project. I don’t want to do business with CitiBank, but even though I’ve stopped using their card, it hasn’t lapsed. I may just keep it for the sake of having one (1) credit card but use a debit card or cash going forward.

      • MAN…that’s surprising. One would think Amex would pull out all the stops to replace the lost business from the Costco split…Gotta tell ya their customer service…. with me anyway….has been stellar….But $75 is $75….

      • Apparently — I should’ve written this down; sorry to have lost the reference — Costco demanded some concession from AMEX and AMEX refused. If that’s true, American Express must be pretty rigid about its business plan.

        And I have to say, it’s a business plan that’s a little hard for me to understand. As a formerly very affluent personage, I might be willing to pay something in exchange for first-rate (or even, these days, second-rate) customer service. But there’s a limit. And that limit is much tighter for the normal, reasonably sane Joe and Jane on the street. Most people are resigned to being treated like cattle and so will not pay to extract common decency from service providers.

  6. Student loans can be very burdensome, though, especially if the student has racked up a lot of them.

    I have a friend who worked on multiple degrees (I think she has a BS, two MAs, and completed most of a PhD) and racked up around $70k in debt. She got cancer at 30, before she had completed her PhD.

    Although she is healthy now, that experience impacted her life in many ways and she walked away from the PhD and started building a corporate career. She’s doing very well and is working in Silicon Valley now, but she is probably going to be paying off those loans until she hits retirement age and will likely never be able to afford to buy a home because of them, either.

    I suppose it could be said that she should have figured out that academia wasn’t for her before she racked up so many loans, but it’s hard to know what the future will bring.

    I’m happy that I was a student back when there were more grants available and before loans dominated the financial aid landscape. I graduated with a BA in 1990 and only $8,000 in loans; by the time I started grad school in 1998, student financial aid was completely different and I had to borrow $8,000 just to fund my first year of part-time classes. (Luckily I was married, living in a two-income household, and could pay that loan back quickly. I hit the jackpot when my then-husband’s academic employer had a tuition exchange program with my school and I had to pay nothing for the rest of my classes.)

    I don’t know how young people deal with so much debt from education. Yeah, if they can keep their loans down to no more than a typical car loan I guess that sounds not too bad, but it’s still a heavy burden to carry when just starting out.

    • It’s a rapacious system. And there’s really no excuse for it. Our country needs a highly educated workforce; putting young people in bondage is not the way to get it.

      Nothing like a life-threatening illness to cast a cold blue light on the prospect of an academic career. In graduate school, I met a woman who at that time was tenured in what was then called “Speech.” Today we call that “Communication.” She was energetic, smart, and already on her way to a distinguished career when she had surgery for some kind of very serious ailment.

      She survived, but the experience caused her to reflect on what she was doing with her life. She quit her TENURED(!) job — I believe she was associate at that time — and started her own business. Basically what she did was to break down what she taught in the classroom into modules. She went into corporations and taught those shorter segments as employee training.

      The business was swimmingly successful. She ended up with several Fortune 500 clients; opened an office in Washington, D.C., and traveled around the world improving corporate employees. Whatever ailed her didn’t carry her away. The last time I saw her, she was wearing more than my net worth.

      • “wearing more than my net worth” That’s a great one, I’m going to trot it out as if I thought of it myself. 😀

  7. I think it is dangerous to classify certain types of debt as good or bad. If a small student loan is the difference between going to college and not going, it could be a very good idea. If you are going 6 figures in debt to pay for a degree that you could get much cheaper at a state school, it might not be a good idea.

    My vote would be for debt analysis to be a more comparative process. Weigh your options. A car loan might be “bad” debt but if it reliably gets you across town to a more lucrative job, then it is a good idea.

    I think the key is to be smart about the debt you get into, and put extra care into making sure you don’t leverage yourself too far.

    • That’s a good observation. My perspective on the car loan question is skewed by my own prejudice in favor of buying a new car. That’s because I tend to keep a car until it falls apart like the Minister’s One-Hoss Shay, and so the longer a car will run, the less it ultimately costs me — and the fewer times, over my own life, I’ll have to deal with car salesemen. However, there’s much to be said for buying a car second- or third-hand, after it has largely depreciated. Then you get something that will carry you around without carrying you (heh) to the cleaners.

  8. Soooo to continue in this vain of “smart debt”. I get to looking around for “financing opportunities” and on my credit union’s website discover they have gotten a bit sophisticated. They are now offering a mortgage which is a “10 year balloon” with 30 year amortization…. for….. 2.25%. This makes the monthly payment for a $100K….about $386 a month. So if a person was to take this $100K and invest it at ….say …. TIAA-CREF….and yield just 10%…it would be profitable. Leave the investment alone and let it compound…it get’s crazy….a yield of say 16% and it get’s really crazy. Pretty sure I can make $386 a month selling apples out of the back of my truck. If interest rates return to their historic norm….one looks like a genius and has an interest rate that other’s just dream about. BUT there is a possibility of failure….which DW points out all too well….as she gives me the “thumbs down”….I struggle…..

    • What? You’re getting 10% at TIA-CREF?

      Let me in, let me in.

      • Probably could, when the market’s really rolling. I average 9% with Fidelity , but it’s not all mutual funds. It’s professionally managed, with a diverse blend of stocks, bonds, mutual funds, and whatnot. Sometimes the return is higher…one notable month which will go down in the Permanent History of Personkind, the thing returned TEN GRAND in a single month. But it’s capable of losing mighty big chunks, too. Over time (sometimes a LONG time), though, it all averages out.

        When I was working for GDU, one of our choices for our 403(b) was TIAA-CREF. I found I did better, over time, with Vanguard, but naturally the state took it away from us at the first opportunity. Switched to Fidelity — the choice of funds we were allowed to pick wasn’t great, but it was better than a credit union savings account, anyhow…

      • Anne….I tell ya it’s been crazy. About 5 years ago a dear friend of mine became ill and it was discovered he had brain cancer. Sadly within a year he was gone ….poof!!! Leaving his family in a real pickle financially…I decided right then to set aside the tuition money for DD2’s college education. So I did some research and sent away the money to TIAA-CREF and told DW if anything happens to me this is to be used to get the kid thru school. Well it turns out we didn’t need the “insurance policy” as the kid graduates in a week and everything is bought and paid for. In the interim this money has doubled. Of course it is not guaranteed but one year up 36%….couple of years in the 20’s….I haven’t touched it…It has shown remarkable growth and the fees are pretty cheap as well. So when I say 10% that’s pretty conservative. To double in less than 5 years….well that’s just crazy….

      • @ JestJack– That is truly amazing. Are there any specific funds or strategies you’re using within TIAA-CREF?

  9. The funds I speak of are the TIAA-CREF Growth….and the TIAA-CREF Growth and Income Funds…I am/was a bit troubled because these funds had A LOT of money in Apple …like 5-7% of the total fund. To be clear I am not a professional investor and this is only my experience….”Your mileage may vary”…