Old School Debt Thinking

So Financial Samurai and I (with MoneySmartBook) had a bit of a Twitter discussion about how to use money and Debt. I kept with my standard statement that there is no such thing as good debt, there is only debt (and it is all bad). This is a very old school view on debt (but not that old school, since this is pretty much how the previous generation looked at debt), but I stick to my guns on this, that attempting to build wealth while still carrying significant debt is a mistake, and Debt Reduction should happen before significant wealth building exercises.

The concept of Good Debt is sold by Banks, Credit Cards and others who do not want you to feel guilty when you borrow money (it is especially espoused by folks who wish to charge you 10% more than the prime rates), so I think Good Debt is pure marketing hype. It’s like saying you have a Good Cold Sore or possibly a Good Case of Gonorrhea (maybe I am being overly melodramatic, but you see my point).

Inevitable Debt

There is Inevitable Debt and that is a Mortgage (possibly Student Loans, if you are paying for education yourself), Inevitable Debt is a necessary evil in your life, because you need it to get the two things you need to live: Shelter and Skills. I realize most of us (me included) cannot put together enough money to buy a house without help from a bank, but calling it “Good Debt” is simply sugar coating a bitter pill. This debt should be (assuming you don’t have other debt), the main thing you should want to pay down as soon as possible (not figure out whether you should pay it down or invest “wisely”).

There was another comment about investing money and making more investing than the amount you might save by paying off debt, but that is a dangerous plan (in my opinion). No matter what you invest in, you cannot be certain you will get the pay back that is promised (did someone say Maddoff), but paying down debt you can see what you will be saving in interest charges, take the sure thing. Would you take your mortgage payment and gamble it in Las Vegas? (if you answer yes, please seek professional help you are way outside the scope of this blog) No, you wouldn’t, so why is it OK, to take possible debt payment funds and gamble it on investments?

I am not saying that there won’t be folks who comment on this saying they easily made more money investing than paying down their Mortgage, I am not contending this may not happen, but any money you invest with, you must be willing to lose (again very old school), and anyone who says otherwise, simply wants your money.

Yes, the model may seem different in the U.S. where your Mortgage Interest payments are deductible, but why does this mean paying off debt is a bad thing? You can show me all the math you want, but at the end of it, if you don’t own the shelter you live in, and are carrying debts into your retirement, why is this a good thing?

Debt Sucks!

Simple, isn’t it? Don’t just mean it in the derogatory way either, Debt Sucks money out of your pockets, and may well suck the life right out of you.  In the middle ages there was a place called Debtors Prison, for those that owed money, I am not saying that was a good idea either, but it is only in the past 30 years where the concept of Good Debt appeared and I think it is a load of crap.

Pay off your debts, then worry about investing later. If you want to live on the edge put money in your RRSP and take the money you get back in taxes and put that on your Mortgage (but I still think paying your mortgage off first is a better way).

Remember, interest rates will not stay at these levels for much longer (I should know, I had a 5 year Mortgage at 11% and thought that was a great rate).

{ 9 comments }

{ 9 comments… add one }

  • optionsdude March 30, 2011, 5:12 AM

    The older I get, the more I agree with you. Debt SUCKS! I would offer one caution about pre-paying your mortgage. I would set it aside and pay in one lump sum. I have heard too many stories about someone losing their home because they lost a job and couldn’t access that equity. If you owe even one penny, you are at risk of foreclosure. So definitely set aside a cushion of two years of living expenses if you plan to pre-pay a mortgage. Otherwise, I like what you say. I know that I can’t retire until all debt is paid off.

    Reply
  • Eclectic Investor February 28, 2011, 12:52 AM

    Hmmm … second try, hopefully not a duplicate.

    I disagree – IMHO “good debt” is tool like any other. If you don’t understand it or misapply it, you will be burned. If not, it can be an advantage.

    Case in point, between Nov 2008 and Apr 2009 I used my home equity line of credit (HELOC) to buy bargain dividend paying stock. The dividend income on a cost basis of 8% to 30% have been pre-paying the mortgage.

    I’m now selling some of the shares to payoff the mortgage early. The capital gains (or downside protection in a dropping market) are 100% to 300%.

    In the big picture – I added debt that when it was mortgage debt, I was comfortable carrying. This time around, it was tax-deductible investment debt.

    Note that my cost was 2.25% to 3.00% – so dividends alone made this profitable.

    If one goes overboard, picks the wrong cost or investments, then yes – it could be a disaster. But having lived through other crashes, I had a good idea what was oversold and had a good chance of rebounding.

    Cheers

    Reply
  • Patrick February 18, 2011, 9:46 AM

    I don’t even go for “inevitable debt”. I have no mortgage and I never plan to have one, and I never had any student debt. Am I so unusual that I somehow avoided debt that others would find “inevitable”?

    Reply
    • bigcajunman February 18, 2011, 9:51 AM

      Yes, you are in a very small minority of folks who have avoided debt (in my opinion), and you should be proud of your achievement.

      Reply
  • Evan February 17, 2011, 12:11 AM

    I think the term inevitable debt, I would also go with justifiable debt. There is a purpose to it. There seems to be a lot of bloggers who are hardcore one way or the other…there is nothing wrong with calling it down the middle (50% pay down debt 50% try to build something).

    Reply
  • Financial Uproar February 15, 2011, 3:19 PM

    I like the term “inevitable debt”. I signed up for a 25 year mortgage 2 years ago, and I’ve paid it down aggressively enough I have about 16 years left on it. I do invest in stocks as well, I try to split the money between going down on the mortgage and investing.

    Reply
  • My Own Advisor February 15, 2011, 10:08 AM

    I’m with you BCM, debt scares the heck outta me. It does suck.

    Reply
  • Money Beagle February 15, 2011, 7:00 AM

    Right now we are applying a good portion of our extra money towards paying down our mortgage. It’s roughly a 6% rate and while it may get a better return elsewhere, there is a comfort feeling knowing that we owe less, something that I think is important for people to factor in when they’re determining whether to pay off debt or invest.

    Reply
    • bigcajunman February 15, 2011, 7:23 AM

      Precisely! This whole “I am going to get rich investing and THEN I’ll be able to pay for everything” is a fallacy put forward by investment houses and BMW dealerships.

      Reply

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