Given the relative success of my Let’s Define Retirement article, I figured I’d take another swing at a term that I hear a lot these days. That term is debt-free.
When I write, what is Debt-Free, I mean: no debts, owing no one any money (or owing anyone no money, if you prefer).
This is ground zero:
Definition: if you owe any money you have debts,. If you owe no one any money, you are debt-free. Simple isn’t it?Big Cajun Man
I do not believe in the Good Debt, Bad Debt theory. I have said All Debt is Bad more than once. The concept of Good Debt was created by Banks and those who wish to lend you money. No reason to feel bad, but it’s like Ice Cream companies saying that there is Good Obese and Bad Obese.
I thought I didn’t understand what Debt actually meant, but I looked at Dictionary.com and found Debt defined as:
something that is owed or that one is bound to pay to or perform for another: a debt of $50.Dictionary.com
There are other definitions. I invite you to look it up in your dictionaries, but in my mind that is Debt.
From this Debt-Free means owing nothing or not bound to pay to another, thus, a total debt of $0.
People say that debt-free is when your net worth is above zero, this is a misnomer . If my house is worth $500,000 and my investments worth another $50,0000, but I still owe $200,000 on my house, that does not mean I am debt-free. It means that if you give me enough time, I could get rid of my debts, that is not debt free. I still owe $250,000, so I am not debt-free.
Do I Mean All Debts?
I am also speaking of all debts, so if your parents were kind enough to loan you $50,000 to help with your home’s down payment. If you have paid all your other debts off, but you have neglected to pay back that loan, you are in debt. If you owe your family money and you have no other debts, what kind of schmuck are you to not pay them back? (look up schmuck in the Joys of Yiddish)
Here is my reader question, am I wrong about what is Debt-Free?
car leases and cell phone contracts are debt too no? You are obliged to pay them.
No disagreement on that.
I don’t really care about being debt free. What matters more to me is net worth and assets/debt ratio. As long as they are getting better each year than I’m a happy guy. If my mortgage is only 2% interest rate what is the rush to be debt free?
When your mortgage goes to 6%?
At that point being debt free becomes a higher priority. As the rate creeps up I will shift $ from investments to debt retirement. If my mortgage had a 10% rate I would have lump-summed it down to zero by now without touching any registered investments.
So you are investing using this debt? You have found an “investment” that pays better than 2% a year? You don’t owe much on your Mortgage? In that case, maybe you are making the right decision (for you), but for most Canadians paying down DEBT is still their best “Investment”.
$400k equity in house, $420k registered investments, $150k non-registered, $30k TFSA, $95k mortgage, no other debt. Investments are 80% equities. You could argue that I should not have any fixed-income investements and should sell those and use the proceeds to pay down my mortgage.
I could, but whatever makes you comfortable, given you COULD at any time pay down your mortgage by liquidating your non-registered investments (and hopefully have about 30% left over) maybe you are just fine, but I’d rather not have the mortgage just for nuisance sake.
Great post and comments. What about RRSP contributions? Would the tax liability be considered a debt?
Yes, but you should always look at your RRSP’s with an eye towards the nominal tax rate to withdraw it. This would mean before you retire, they are worth less than after you retire (for many of us).
I didn’t know there were people who considered a positive net worth “debt-free”. Must be something they hope to achieve eventually after making their “good investment” in a luxurious overseas vacation that they “really deserve” instead of paying off their credit card bill that’s “just so unfair” 🙂
That said, as Michael pointed out I’m quite comfortable with not being debt-free. With current interest rates it could be harmful for someone who is well-organized to rush to that point. I may never be debt free and as long as the net worth keeps advancing, that’s ok.
I have no debts ATM, but I know that I will owe $1700 in taxes in April 2013. That means I am having to save money for that time so that I can pay the money owed.
Is it a debt right now? Technically no, but it will be one eventually… If someone gets REALLY technical, I owe 5 months of taxes NOW, so yes? No? Dunno…
You can make the same arguments about if you Rent, are you permanently in Debt? What about the Windows on my house? They will eventually have to be replaced (of course), so is that a debt?
“From this Debt Free must mean owing nothing or not bound to pay or perform for another.”
By that definition, I suppose we can come to the conclusion that taxes are a form of debt.
I think taxes are part of Cash Flow as well?
Taxes adjust with your income and come off your gross. Yes, if you don’t pay them they’re owed — and that would make you not only a debtor but an idiot. It’s just an ongoing bill that is required if you want to be part of the economy and earn money (you can voluntarily retract if you wish). It’s your part of the bill for society’s critical infrastructure, as well as your portion of the bill for eHealth and F-35s.
Render unto Caesar that portion of your cash flow which is Caesar’s. Render unto Little Cesar’s that which is payment for your pizza and Crazy Bread.
Monthly bills, credit card included, are just part of cashflow management assuming you pay them off every month.
Great post, BCM. Bang-on.
I’m with you that just having a positive net worth is nowhere near the same thing as debt-free. I guess there are some fine points. I routinely owe money on my credit card at the end of each month. I also owe money for the hydro, natural gas, and water I’ve consumed. But these things don’t really seem right to count against someone for debt-freeness. As long as your monthly accounts are paid in full each month and you have no other debts, I’d say it’s fair to call yourself debt-free.
All good points and clarifications on the statement, I have no issues with them, makes for a better definition.
Totally agree — with the post and Michael’s comments. I’m going to nitpick on the credit card thing though. IMHO, if you’re using it as a convenience — e.g. in place of cash to order something online — then it’s not a debt if you pay the balance every month. (It’s just a tool for planned spending.)
If you’re using it to buy time — e.g. I’ll can’t afford x now but I can afford it on my next pay cheque — then I think it’s debt territory. In the first scenario, you’re spending money you already have. You could pay your credit card bill right after you bought your item. In the second scenario, you’ll spending money you’ll have in the future. (Which is essentially what you’re doing when you take out a car loan or mortgage.)
Maybe this doesn’t make much sense 😉 Agree? Disagree?
The Cash Flow statement by Joe is topical for your point of view on paying things off every month. As soon as you are attempting to delay payment, you are not really out of debt, since that is a debt?