I'm a Girl Scout leader and I teach kids to play with matches. I always ask them if matches are dangerous and they all generally agree they are. I then ask them if pencils are dangerous, and they all reply that they are not. I then ask them if they want me to poke them in the eye with a pencil, and of course, they don't. At that point I explain that matches and pencils are both tools. Use them properly and they are useful; use them improperly and they cause pain.
So what about debt? Is debt a tool or an evil? Debt is a tool, but it is a tool that is often misused. The misuse gives you bad results but those results don't make debt a bad thing any more than poking someone in the eye with a pencil makes pencils a bad thing.
Misusing Debt
What does it mean to misuse debt? It is when you buy something that you don't need and can't afford. It is when "debt repayment" is a major part of your budget for a long period of time and when it keeps you from saving for the future. It is when the interest on debt becomes a significant expense. It is when it takes longer to pay for something than it takes to dispose of it.
Using Debt as a Tool
Debt is a way to obtain something now, and pay for it over time. Sometimes you have no choice. If you don't have health insurance and end up in the hospital, you will owe the hospital money for some time. On the other hand, at times we do have choices. If your uninsured car was just totalled, you need another one--but you don't need a new car. The cost of your "new" car shouldn't keep you in debt for a long time and you don't want interest to make you pay for the car twice.
On the other hand, if you need new furniture, are buying furniture you can afford, and are offered 2 years same as cash, why not take it?
If you have the choice of cleaning out your savings to buy a car, or financing the same car at less than 2% per annum for three years and you expect the car to last ten years, I dont' think financing it is a bad idea.
While some super savers may be able to afford a home without a mortgage, for most of us, foregoing the mortgage just means more money thrown away on rent.
Like matches, debt is a tool. Like matches, debt can burn you if misused. Like matches, debt can make life much easier.
I absolutely agree that debt is a tool, not an evil. The problem is how rampant the misuse is. When it feels "normal" to have a high car payment and credit card debt, many people don't even realize they are misusing it. I believe financial literacy is the key.
ReplyDeleteI am working with a group of "young" (28-40 yr old)mothers.They are all significantly in debt. They all have the income to handle their debt. It doesn't leave them lots of extra, but they can handle it. They all are saving for retirement. We started with how to make a budget.
ReplyDeleteThe anxiety I hear is , "What happens if I(or SO) lose a job?" That is a reality for this generation. They know job loss is a norm.
This group is in the $90,000-$125,000 (medium income for dual professional income in the DC area) a year and more than half of their net goes to types of debt or set bills. House, student loans, furniture, cars- even private school can be paid for over time. Now add on health care, insurance and technology---oh lala. We haven't even gotten to food and child care.If one of them has an incident that takes them out of the work force....problems.
Now you can see why people like me suggest they should attempt to buy with cash. Start saving. Drive that car a few thousand miles more and love that "starter"couch. Get out of debt- and stay out. Bank mortgage is worthwhile- but not at the 40% of the type of house that the bank will lend you...
I know a few people who leveraged debt to have a successful life. One is my sister.
Like investments- only do something that will not keep you up at night.
Absolutely a tool. I used to be so debt averse and now I have a better understanding of how to use it to get ahead.
ReplyDeleteGreat post. I like how you've used the uninsured car analogy vs. the insured car analogy... Although I'm not going to lie, the thought of an uninsured car is a scary thought! Always a great idea to have a car insurance policy that will have you covered in the case of an emergency.
ReplyDelete- Jackie from KW Insurance, the trusted choice for car insurance in West Roxbury MA