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The Case Against a Life Without Debt

by Flexo on February 20, 2007

in Debt Reduction

Getting out of debt is a great goal to have. Perpetual debt is like slavery. All the money you earn beyond your necessities for living is turned over to someone else in the form of debt service and interest, and in many cases even your basic needs are paid on credit. Creating and enacting a plan to break this cycle is admirable.

Every once in a while I hear about someone swearing off all forms of credit as evil or unnecessary. Here are some reasons from MSN Money why being debt-free can be costly.

1. With no credit history, you will find it difficult to get a mortgage with a decent interest rate or at all. Those completely against debt shouldn’t be looking for a mortgage in the first place, though. Living at home until building up enough of a savings account to pay for a house in cash might be a bit too much to ask for most people.

Not all debt is created equal… Some debt — mortgage debt being the classic example — is tax-deductible and gives individuals the opportunity to improve their quality of life and set themselves up for a comfortable retirement.

Lenders consider those with no debt only slightly less risky than those with bad credit.

2. The article gives the example of a couple who decided to live debt-free after graduating from college. They saved to pay for their home with cash.

The family stayed completely debt-free for nearly two decades. Then the couple decided to embrace a little debt in order to build the house of their dreams… To pay off their $150,000, 15-year mortgage faster, the couple has been prepaying it with any extra money that comes in. After just three years, the balance is down to $79,000.

Mathematically, if they didn’t pay down their mortgage faster, they could have invested their extra funds.

Mortgage and student-loan debt are generally fairly cheap and leave you with an appreciated asset. Plus, the interest you pay on these loans is deductible. Having this kind of debt can actually get you ahead if you invest extra cash rather than put it toward your loan principal.

This requires discipline, a trait that some people have, some people don’t, and most people think they have but don’t.

I’m not going to preach. I can’t tell you that a life without debt is the only way to live, or even the “best” way. Mathematics show that in some cases the user of credit pays off. The only people who believe mathematics contain the answers to all life’s problems are mathematicians.

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Flexo, the owner and creator of Consumerism Commentary, has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow him on Twitter.

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  • tinyhands
    Spot on. Since "debt-free" isn't necessarily ideal, we need a new term or catch-phrase to describe "thriving with intelligent and manageable debts". My specialty was finance, so I'll leave it to the marketing folks. ;)
  • NCN
    So, it makes sense to borrow money and PAY INTEREST so that I can get a TAX DEDUCTION? No way. While I'm thankful for the tax deduction, justifying the PAYING of interest b/c of a tax deduction is crazy. How about this? Instead of a tax deduction, invest in pre-tax retirement and have tax-free income. You don't have a "tax deduction" but you have a smaller amount of income which is taxed. Being debt free is awesome, by the way, whether the mathematicians agree, or not!
    NCN
  • ntguru
    NCN, your comment about paying 100% to save 30% does make sense, but only if you do not already have a mortgage. I think the point is that if you already have a mortgage like the couple in the example, it often makes more financial sense to NOT pay down the mortgage faster. If you locked in a 5 or 5.25% mortgage rate and your marginal tax rate is 25%, your effective mortgage interest rate is about 3.5-4%. Instead of paying an extra $x a month toward that effective 3.5% loan, you would be better off putting that $x in a money market account making 5%, or into stocks which over time are 8%+.

    The other major advantage of putting the $x into something like a money market account is liquidity. It's easy to use in an emergency.
  • tinyhands
    NCN-
    Which pre-tax retirement investment generates tax-free income? Every pre-tax retirement account I've ever heard of is merely tax-deferred, and unless you're self-employed, the average person cannot contribute enough to significantly impact his overall tax liability.
  • MossySF
    There is one pre-tax vehicle that will produce tax-free income -- a HSA when used for qualified medical expenses.

    If you have the discipline, you can aggressively invest the difference between buy/rent and in less years than a typical mortgage, have enough money to buy a house in cash. So for the rare few who can pull it off, no credit will not hamper them.
  • It's very true about lenders and no debt. You may as well be back at square one with no purchases on your record. You can't win the debt game because it's not designed to be won, just try to play wisely without digging a large hole.
  • Alias
    ntguru - you are making 2 very common mistakes in your logic.
    1 - you are not including the risk you take when you borrow money (yes it is real and part of a formula).
    2 - you don't include the taxes you pay on the invested money growth.

    When you combine those 2 factors you don't actually make any money using your method and you take on more risk.

    Bottom line is...pay off your mortgage as quickly as you can.
  • I am not falling for the debt free argument. Fine, I could buy a house with cash in the next 10 years if I save enough. What about the rent I will pay for the next 10 years? What if it's in the best interest of your family to own a house *now*?

    A good example is a student loan. You need it for your college education. Now, you may wait for 5~6 years and generate enough cash to fund your education without loans. One doen't need the math in this case to realize that 5~6 precious and productive years would be wasted.

    Forget about mathematics, there are things that need to be done at the right time. Look at debt as an instrument that helps you do just that. Of course, there is a charge... but don't all conveniences have some charge associated with them.

    It's like a gun. You could probably use it wisely for your protection or shoot yourself in the foot. :)

    Flexo, sorry about the extra-long comment.
  • tinyhands
    Mossy-
    Unless you know with some certainty what your qualified medical expenses are going to be, the use-it-or-lose-it aspect of many HSA plans is unattractive. (For those fortunate enough not to be familiar, this means that any unspent pre-tax dollars are forfeited, NOT returned to you and/or taxed. And yes, this stipulation is common in HSAs.)

    For the small (I sincerely hope) percentage of persons with considerable health-care costs, HSAs are useful beyond their basic premise. For the rest of us, I don't believe the materiality of a few hundred dollars warrants calling this a 'tax-avoidance investment strategy'. Not long-term anyway, and not for retirement savings.
  • MossySF
    You are wrong. HSAs are not use-it-or-lose-it -- FSAs are. Any unused HSA money rolls over next year. Upon age 65, it then becomes an IRA plus where you can use the money for any reason by paying income tax. Qualified medical continues to be tax-free.
  • tinyhands
    I stand corrected. I have never never worked for a company that offered a HSA (only FSA) so I was unfamiliar with the difference.

    However I still contend that unless an individual has substantial (qualified) health-care costs, a HSA will not provide material tax-avoidance, merely tax-deferral.

    We have strayed from the original subject though.
  • Looks like we had the same idea!
    http://www.kmull.com/2007/02/26/the-same-idea/
  • Yana
    Having been a big user of credit in the past, but never taking on the debt of a house or car, I've done a complete turnaround in attitude. I don't want debt of any kind or to pay interest. To me, there is no such thing as "good debt". I bought a new car with cash a couple of months ago, and don't expect to have a home unless I can purchase it outright. I don't understand keeping housepayments for a tax write-off, but a friend of mine did just that, when she could have paid off the home and actually owned it. In deciding to purchase a new vehicle, I heard from friends that the vehicle would depreciate as soon as I drove it off the lot. I don't understand why this matters, as I didn't plan on selling it as soon as I drove it off the lot. Nor do I plan on purchasing a vehicle every two years. As far as a home, I'd like one for a place to live. Its appreciation would serve me if I sold it. Outside of that, it seems that people like equity because it is a way to incur more debt, and pay more interest.
  • flexman
    LIving debt free is the way to go! I've been on both sides of the fence. Why would I spend a dollar to save a quarter like most of us do? I'd rather spend a quarter to save a dollar, wouldn't you?
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