Debt is dangerous. Like a fishing hook, it might look like an easy meal at no cost, but there’s an awful barb underneath. Debt is easy to get into. It promises that you can have what you want NOW! That’s enticing, but there’s a great danger of debt that you should be aware of before diving in.
Danger of Debt 1: Debt Enslaves
No one wants to be a slave, it’s not something anyone would choose. Yet millions financially enslave themselves all the time. And let’s be clear, being a debtor enslaves you. You are bound by law to a cruel master who demands their interest every day, every week and every month. There’s no wiggle room, no leeway, you must pay up. To be indebted means you lose your freedom to do what you want with your money. You must first pay your debt. And with some people leveraged to the max, that means being forced to say no to a lot. So that one yes to a purchase may mean many more no’s. Maybe think before you go into debt, what will you have to say no to in the future. A big house, YES, fix the car, NO, date nights, NO, holidays, NO, giving, NO. Debt is a horrible master that must be paid for little to no gain. It’s all cost. So be aware of the real cost of debt before you say yes to tapping that credit card. Debt enslaves and takes away your financial freedom.
Danger of Debt 2: Debt Stresses
Not only does debt enslave but causes some serious stress. When the bills are growing and you have a debt and growing interest must be paid, that means; STRESS. Lots of stress. And stress destroys your quality of life and your relationships. Money is one of the big drivers of divorce, but proceeding that is money stress, usually the result of too much debt. Whenever debt is present, stress is right around the corner. I think we all want as stress free a life as possible. If that’s the case then maybe consider avoiding debt and its stress.
Danger of Debt 3: Debt Spirals
Just as investments compound and grow, so debts can compound and spiral. This is particularly true of credit card debt. Banks and credit issuers love nothing more than for you to pay off the minimum amount. In fact they positively encourage it. Why? Because your debt spirals. A small credit card debt can grow and eventually spiral out of control. Eventually you hit the point where you can’t pay it off, particularly if life throws you a few curve balls. Falling into a debt spiral is a one way trip to bankruptcy. And that’s not a road you want to walk down.
Danger of Debt 4: Opportunity Losses
If your money is constantly paying of interest debt and debt repayments, that’s money that can’t be saved and invested. Just $100 invested monthly over a 30 year period can grow to over $160 000. That’s a lot. But if that $100 goes to interest and debt repayments, that’s $160 000 of opportunity loss. Debt ties all your money up and keeps you from investing and compounding for your benefit. Instead you compound interest for the benefit of the banks. So who would you rather enrich? Debt strips from you the ability to grow real wealth. It’s an opportunity loss.
What About Good Debt?
Perhaps you’ve heard the terms good debt and bad debt. Bad debt meaning debts on depreciating assets, things that reduce in value after you buy them. For example, anything you buy with a credit card and can’t pay back in full! But good debt is debt for appreciating assets that grow in value, like a house or a business. So, is there good debt and bad debt? I think that’s a stretch too far. All debt enslaves, all debt stresses, all debt can spiral and all debt creates an opportunity loss. In that sense all debt is bad. Your house debt can create extreme mortgage stress, curtail your freedom to spend and lock up all your money for a lifetime, even though it appreciates in value. Is that a good debt? I don’t think so! It’s certainly better to have an asset that grows in value than going into debt for something that reduces in value to nothing. But it’s still bad, just not as bad as it could be. In fact, the only way to make debt good is to minimise it. Let me explain. A very small debt relative to your ability to pay it off creates less stress, less slavery, is less likely to spiral and has a smaller opportunity loss. I owe you $100, no worries, I can handle that. A big debt relative to your ability to pay it off creates high stress, deeply enslaves, easily spirals and has a massive opportunity cost. I owe you $25 000, oh no how am I ever going to pay that off! So in my books, a good debt, or perhaps more accurately, a less bad debt, is a small debt (relative to your ability to pay it off). And the best debt of all is one that is paid off in full!
So What Debt Should You Consider?
You should only consider going into debt that is extremely manageable and is for something that increases in value or offers long term value. That means, small debts, not big ones. Let me say that again, SMALL debts not BIG ones relative to your capacity to repay them. Let’s think about the family home. If you buy a modest home, you may well find the mortgage cost is less than what it would cost to rent. That makes sense to buy with some debt. But it may well mean buying a smaller home to have a smaller more manageable debt than a big one with big debt. A small debt will be paid off far quicker and without the stress. It may also mean saving up for longer so you require far less debt or buying in a far cheaper region. But the point is to minimise your debt as much as possible. I think this is especially the case with buying a home. Our tendency is to spend up to the maximum a bank will lend us. That’s a bad idea. It’s good for the bank and the mortgage broker, but bad for you. Instead borrow way less with a far, far larger buffer. Less slavery, less stress, less chance of spiralling, less opportunity cost. I’ve seen way too many young people get hugely indebted on the big house and spending their whole lives stressed out trying to pay off one thing. You end up paying more than the house is worth in interest. It’s just not worth it. Small debt, manageable debt.
These are the other debts that you might consider, a small debt to buy a business with a proven track record that easily pays itself off with business earnings. An investment home where the rent comfortably covers the entire mortgage cost, even if rents decrease or interest rates increase. A student loan for an education in a field that is very likely to easily reimburse the amount borrowed. Of course, no debt is always better than any debt. But if you do go into debt, think smaller is better, easily management, easily repayable.
What Debt Should You Avoid At ALL Costs
Most debt falls into the avoid at all costs side of the ledger. As I said, the best debt is no debt! Credit card debt, car loans and personal loans are the worst of the worst. The thing you buy becomes worthless and you are left to pay high interest for a very long time. This is be avoided at all costs. If you can’t pay off your credit card in full every month, cut it up and throw it away. Buy a beat up rust bucket before you buy a shiny new car on debt. And avoid personal loans, pay day loans and other loan sharks. They are all bad news and the danger of debt is greatest for these. Whatever you can to do to avoid these kind of debts, it’s worth doing to avoid it!
But What About Debts You Have Now?
Your aim should be to get out of debt as quickly as possible, or at the least, reduce them to a very modest, affordable level. You definitely want to remove any high interest debts. I suggest doing a detailed budget, making drastic cuts wherever possible and setting up an aggressive payment plan. You can check out my budgeting posts, How to Create A Budget You Can Keep and The Purpose of Budgets. Pay off way more than your minimum repayments so you pay off the debt faster and live off what you have left. As soon as you income hits your bank account, the agreed amount should go to debt repayment, leaving you the rest to live off. This will mean some belt tightening and saying no to lots of things for a time. But the result is less slavery and less stress with every passing week. Here’s a few other ideas keeping in mind each person’s situation will be different.
- See if it’s worth selling the indebted asset. Can you downsize your home or find a cheaper car that will do for now.
- Pay off the debt with the highest interest first until it is fully paid off, then the next debt, etc.
- Don’t decrease your payments as you get ahead or when interest is reduced.
- Investigate if you can consolidate your debts into a lower interest loan.
- Move credit card debt onto a no interest offer card and pay it all off within a year.
- Consider how you can increase your income and put any increase into debt repayment.
- Cut your expenses to the bone, and pour everything you don’t spend into debt repayment.
The Other Side of Debt
On the other side of debt, you will be free. Free to say yes to vacations and date nights and giving because you said no to debt. There won’t be the stress of an unexpected bill because you will have plenty spare to cover it. And instead of spiralling debt you can have spiralling wealth, investing excess income in growing investments. The danger of debt is very real. It’s hard work getting out of debt, so perhaps the best advice is to not get into it in the first place. The only good debt, or not so bad debt, is a small debt and the best debt is one that’s paid off in full. Be wise.