This is the third in a series of posts called the “Two-Sided Coin,” where TSD’s Jon Gorey and Holly Johnson take opposing viewpoints on personal finance topics.
Holly: Debt Is a Wolf in Sheep’s Clothing
On one hand, debt has allowed many of us to achieve the American dreams of home ownership and higher education. And for millions of would-be entrepreneurs, going into debt was really the only way to bring their dream of starting a business to fruition.
On the other hand sits debt’s dark side – one where revolving balances and high interest rates stand between us and our dreams.
The real problem Americans have with debt isn’t the debt itself – it’s how we use it. While borrowing money to finance a home for your family or a college education can be a smart move that pays off, and even an “investment” in some ways, borrowing money to finance a brand new smartphone, a vacation, or a new pair of shoes — which is exactly what you’re doing if you’re carrying a credit card balance — will only hurt you in the long run.
As someone who once had tens of thousands of dollars in consumer debt, I can speak to both sides of the equation – the before and the after. My husband and I carried a home loan, car loans, student loans, and some credit card debt in our early 20s, only to realize we had grown tired of the monthly payments and what they meant for our lives.
Because we were paying up to $1,000 in loan payments every month, we had trouble saving money and getting ahead. We paid thousands of dollars in interest every year, only to continue the same behaviors (trading in our cars every few years, making minimum payments) that kept us “stuck.”
Once we decided to have children, however, we knew we had to change. By creating a zero-sum budget and sticking to it, we paid off our car loans, student loans, and consumer debts in a fury. Once those debts were behind us, I had all kinds of realizations about our previous situation, and what got us there. Here’s what I learned:
- You can finance anything. Part of our problem with debt is that it’s far too easy to get into. As Americans, we have been programmed to finance everything from our cars to our cell phones, and even our clothing purchases and groceries. With easy credit available at every turn, getting into debt is a piece of cake. And once you start digging, it can be hard to turn your situation around.
- Debt can make you feel “trapped.” The wrong kind of debt – consumer debt – has a way of taking over your life. Instead of saving money to reach your goals and get ahead, you get into the habit of spending all your extra money on debt repayment. And because you don’t have a lot leftover, it’s that much easier to get into more debt when an emergency pops up. If I have learned one thing, it’s that debt is a vicious cycle. And once you have the disease called “debt,” it’s hard to shake it off.
- Debt holds you back from your real dreams. When you’re struggling with debt, your dreams seem like exactly that – a dream. When all the money you work hard to earn is siphoned away somewhere else, it can feel like your long-term goals will never come true.
Once we became debt-free, all of the negative feelings we had about money and our hard work melted away. Not only did we start saving a much larger percentage of our income, but we learned the true value of the money we worked so hard to earn.
And in hindsight, I now realize that learning the value of our income was one of the best things that has ever happened to us. Where we once worked 40+ hours per week just to give it all away, becoming debt-free made us keenly aware of what each of those dollars meant.
As a result, we became a lot more thoughtful and judicious with our spending. While we still have a small mortgage on our primary home and rental properties, I can say with certainty that I’ll never borrow money again.
Even when interest rates are cheap, debt is an expense I can no longer bear. The financial cost is only one side of the equation; the price of freedom is the other. Where I once surrendered that freedom willingly, I now know better.
In the end, we would all be a lot better off if we saw debt as a tool we could use to get ahead instead of a means to buy things we cannot afford. You can learn this lesson the easy way, or the hard way, as I did – but you’ll learn it nonetheless.
As Americans, we have forged a strange relationship with debt – one built out of both necessity and desperation. Using debt to get ahead is sometimes necessary, but the decision should never be taken lightly. Ask anyone who is deep in debt how they got there, and they’ll tell you just how easy it was. One dollar borrowed leads to another and another, until the interest starts to take on a life of its own.
The best way to avoid this heartache is to refuse to take on debt whenever humanly possible. Learn to live on less, treat the money you earn with the respect it deserves, and don’t let debt become your new master.
Jon: Debt Is a Powerful Tool
Nobody likes debt; I’m not going to argue otherwise. Is it better to buy something in cash, with money you’ve already saved up? Of course it is! Who wants to owe money to someone, for months or years on end? I don’t even like owing favors, much less money.
What I will argue is that debt is not the evil boogeyman some personal finance experts make it out to be. It can be a powerful tool to help you build your life. But just like any other powerful tool — a circular saw, for example — it can hurt you pretty badly if you’re not careful with it.
Most people who want to make a major purchase — like a house, a car, or a college education — simply don’t have a few hundred grand lying around, or $20,000 ready to plunk down at the car dealership. They rely on loans to finance these enormous purchases, and there’s nothing really wrong with that. Some people refer to these types of loans as “good debt,” because you’re borrowing money to strengthen your long-term financial situation.
For example, a student who takes out the average $35,000 in loans to complete a four-year college degree will make about $1 million more in lifetime income than his peers with just a high-school diploma. By and large, that’s some very good debt.
Or take a young family who’s been paying $1,000 a month in rent. They decide to buy a $250,000 house, taking out a $200,000 mortgage at a fixed rate of 4%. That means they’ll pay $955 a month, taxes and insurance, for their shelter. In 20 years, their mortgage – the biggest part of that bill — will still be $955 a month, while rents will have climbed to almost $1,500, assuming just 2% inflation. In 10 more years, even if the value of their home didn’t increase at all over the entire 30 years of their mortgage (not even keeping pace with inflation – an unlikely scenario), they would at worst have a virtually free place to live and $250,000 in equity.
That’s some pretty good debt, too.
Good Debt Gone Bad
Okay, so that’s good debt. That’s debt with a purpose. But the trouble with debt and spreading out payments over time is that it can mask the real cost of a big purchase.
Car dealers know this, and that’s why instead of lowering the purchase price during negotiations they’ll try to stretch out the length of your loan — lowering your monthly payments, but not the cost of the car. After all, consider the difference between paying $955 for a monthly mortgage compared with $998. What’s another 43 bucks a month when it comes to something as big as a house? Well, it’s about $16,000 over the life of the mortgage, that’s what. No small difference.
We also tend to spend more with credit than we would in cash. The former is, in a very real sense, pretend money. We’re spending someone else’s cash — namely, our future self’s — so who cares? But we’re far more careful with our hard-earned dollars in hand.
And that’s why debt gets, and often deserves, a bad rap. It’s far too easy to spend more than we ought to when we’re just putting it on our tab — to buy a fancier car than we need, to purchase a bigger house than we can truly afford, or to pick the private university over state school.
Another reason for the bad rap is that some debt is truly, truly terrible: Payday loans, car title loans, and unsecured personal loans with sky-high interest rates amount to legally authorized loan sharks. Avoid them at all costs.
What about credit cards, and their double-digit interest rates? That’s considered “bad debt” too. Borrowing money to buy drinks at a bar or a new air conditioner is not a life investment.
A credit card can be a convenient and rewarding tool in your wallet if you have your financial act together. But for most Americans, they spell trouble. And I’m one of them.
In my late 20s, my wife-to-be and I had just returned from a freewheeling summer in Galway, Ireland — a too-fun town sometimes dubbed the “graveyard of ambition” by the locals, a moniker I won’t dispute. There, we had rented a cheap room in a dingy student house and lived off our tax refunds, meager savings, and whatever money I made street performing (which was pretty considerable, actually — but then, so was our thirst for Guinness).
By the time we returned to Boston in the fall, we had exhausted all our savings and rung up a pretty good credit card tab to boot. We found work again after a couple of weeks at home, but we were still dirt broke for months. We paid for nearly everything on credit card. And when plastic wasn’t an option — e.g., for a deposit on our apartment, or my share of expenses for a friend’s bachelor party — we used those dastardly checks that credit card companies like to send you in the mail for balance transfers and other purposes.
This is all terrible from a personal finance perspective, and it wasn’t long before we were drowning in credit card debt, of course. But there was a bigger problem: I’d already been drowning in credit card debt for years.
It’s a problem plenty of 20-somethings face: I was working low-level jobs in a low-paying industry and living in an expensive big city. No amount of roommates could balance that equation — and believe me, I tried, sometimes cramming into houses with eight or more people.
So I dipped into my credit cards to bridge the gap — a bit here, a bit there. When out with friends, I was the guy who would pay the bill with a credit card and collect cash from everyone else; that was my ATM.
Then there were the big splurges that would take years to pay off: I loved to travel, and Orbitz loved to take my credit card. Red Sox tickets were expensive, but non-negotiable nonetheless. I was trying to be a real musician, and recording and pressing a thousand CDs required thousands more dollars upfront.
By the time I hit 30, I’d been swimming upstream against credit-card debt for eight years and had racked up more than $20,000 in balances.
The whole time, I was making a calculated gamble: That my future self would one day be able to bail out his irresponsible younger brother. The thing is, I knew he was good for it: I was getting better jobs, and I knew it was only a matter of time before I settled down, stopped going out as much, and reined things in.
And you know what? I finally did bail out my younger self, and I don’t resent him for it one bit. My eventual wife helped me get my spending under control. I started paying down my credit card debt with big chunks here and there and an increasingly aggressive monthly payment schedule.
Was it infuriating and frustrating that even as I started paying $1,000 a month toward my balances, more than $200 of it was simply going toward interest charges each month? Absolutely. Were we spread waaaay too thin and dangerously close to financial disaster? Probably.
So isn’t credit card debt terrible?
Well, I wouldn’t go that far.
I essentially financed my roaring 20s and paid them off in my more responsible 30s. And while the whole thing cost me more than it should have, I don’t regret a thing: My 20s were pretty amazing.
In fact, I still have a soft spot for debt — it feels like an old friend by now. I know it’s absolutely stupid and fiscally irresponsible, but we keep a small balance on our credit card from month to month, even though we could easily pay it off from our savings. It makes me feel young — like at least one part of me is still living it up in my 20s.
So, heads or tails, tell us what you think…