On a macro level, debt was a force behind the incredible economic expansion over the past two centuries, and the availability of debt at the family level played a role as well. Despite all that debt has brought society, many financial gurus and authors vilify debt and explicitly call the idea of borrowing money “evil.” Typical mass-produced financial advice often calls for avoiding debt as much as possible. Is this a realistic goal in economically developed nations in the twenty-first century?
For some, it is. There is no doubt that there are many ways families can survive and thrive while avoiding the need to borrow money at all. Avoidance of all debt can be a struggle for most families, particularly in today’s United States. Are the sacrifices worth the effort?
To join in this discussion, you must accept that debt is not evil. All forms of money are tools to simplify the exchange of goods and services. As tools are objects with no inner consciousness, they can neither be good nor evil, as these words indicate a nature of intentions. Intentions require a sophisticated neural network, something lacking as much in money as it is lacking in a doorknob.
If you’re still with me and you agree that borrowing money is not an evil concept, you might also agree that the tool of debt could possibly be used for both wise and unwise decisions, designed by the active neural networks in human beings (the tool-wielders).
From a pure numerical viewpoint
Even though amounts and values of money are normally symbolized by numbers, money is never solely about digits on a ledger. If it were, there would be only one reason to go into debt: an opportunity to use someone else’s money to earn more money than what is borrowed — a sure thing. If I offered you $10,000 without interest with the only caveat that you repay me slowly each month and in full by the end of twelve months, it would be wise to accept the offer, invest the $10,000 in a safe investment like a high-yield savings account, pay me back, and keep the interest you’ve earned for yourself without much effort.
This is what credit cards have been offering, though less frequently recently, with 0% balance transfer offers, or so they’d like you to believe. If you look deeper, there are usually some risks:
- The credit card companies might drop the promotion.
- If you fail to make a payment in time, even if your check arrives on someone’s desk one minute too late, you will owe interest to the credit card.
- The bank might lower the interest rate you are earning in the savings account to a point where the exercise is not worthwhile.
- Your credit score will decrease due to an increased utilization ratio, forcing you to pay more for new loans or mortgages.
The numbers are trickier when you question whether to take on debt at a higher interest rate with the possibility of earning more from a riskier investment, like stocks. Here you have to weigh the probability of not earning more than the interest you will be charged for borrowing the money.
In the end it is a judgment call. You could devise complex algorithms to help you to decide whether to borrow money at one rate for the possibility of earning a higher return on an investment, but anything can happen.
Debt for education
One of the most prominent rationalizations for accepting debt for education, like student loans, is from the purely mathematical viewpoint. People who go to college earn more throughout their lifetime than people who do not. The numbers show that in many cases, money spent for college, including interest payments lasting ten years after graduation, are worthwhile thanks to increased career opportunities and salaries. On average, an individual with a Bachelor’s degree will earn twice as much as an individual with only a high school diploma, though the statistics will differ depending on the field of study and the career.
Thus, it often makes mathematical sense to enter into debt to obtain a Bachelor’s degree, if necessary. There are ways to avoid education debt, such as having parents who have earned and saved enough money to fully fund the education, choosing a free or less expensive school, obtaining grants or scholarships, or even working. When these options fail, the possibility remains that choosing to attend and graduate from a certain college and accruing debt will be a better decision than not earning the degree at all.
Student loans can generally be found with low interest rates or with a portion of the interest being subsidized by the government because it is in society’s best interest to produce a well-educated workforce and thinkforce.
Your career’s start-up expenses
When a new company is formed with a visionary idea, there are often required start-up expenses. These include finding real estate for an office or storefront, furnishing the office or acquiring inventory, hiring employees and paying them salaries, and spreading the word about the new business. I like to compare this process with a recently-graduated student entering a career. Unless the business has received help from investors (who often require that they become part owners), these start-up companies rely on loans.
Similarly, in some cases new employees can be excused for using debt to put them in a competitive position for starting their careers. Dressing appropriately and presenting a professional appearance requires expenditures for which a newly-minted graduate may not be financially prepared. (This is one reason I suggested the gift of clothing or gift cards for recent graduates.) Attending networking events, sending out resumes and traveling to interviews are all start-up expenses that must be financed in order to land the right job.
That first job is an important indicator of the remainder of your career, particularly if you remain in the same career path your entire life (as fewer people do). The better placed and paid you are in your first job, the higher your income will be throughout your career.
If necessary, a moderate amount of debt at the point you start your career will provide the opportunities to place you in a better position for future earning.
Owning a house
Thanks to the prevalence and availability of debt, consumers have reached higher and higher beyond their means. In the 1960s, median house prices were about 2.5 times the median annual household salary and at the height of the housing market in the early part of this century, the multiple was around 5 (source). Saving to pay for a house with cash could take years or even decades.
During the height of the housing frenzy, many families were willing to take on debt using the above numerical viewpoint. House prices seemed to go up without fail, and the prospect of earning more by leveraging a house purchase with debt seemed to make financial sense. Unfortunately, the underlying assumption that real estate prices always increase proved to be incorrect and many families were hurt due to over-leverage.
But that doesn’t mean that it’s never wise to buy a house with help from a loan. Buying a home should not be a purely financial decision. Families often want to create a stable home environment, and settling down in a location with the intent to stay for several decades is a key component of that idea. Furthermore, families with children want to ensure that the free public education offers a quality experience, and regions known for excellent education, in high demand, will often be more expensive.
A mortgage, while a decades-long debt sentence, is not evil. It makes sense for families to live in the best location they desire if they can afford the debt payments.
When else is debt worthwhile?
If you accept debt into your life, there are sacrifices you will need to make. You will also need to accept other sacrifices if you refuse to enter debt. It comes down to personal choice. Is it crazy to be willing to accept debt, as long as it is affordable and well-purposed? Or do you agree with idea that money is a non-intentioned tool, to be used in whatever situation logically calls for it? Are there any other instances where it can be a smart decision to take on debt?
Photo credits: mathplourde, snapped_up
Published or updated June 10, 2009.
{ 15 comments… read them below or add one }
But but but but Dave Ramsey said…..
Juuuuust kidding. This was a good smart list of how you can use debt properly.
I agree that education, career and a home are worthwhile uses for debt. Few of us can plunk down the amounts of money it takes to pay up front for these areas. I also think that in some cases going into a little debt for a car might make sense — if you need it to get to work or for some other purpose. In any case, though, the key to make sure that debt doesn’t overwhelm you is to use it in moderation. Only borrow what you need, and borrow modestly. Just because getting an education is a good idea, doesn’t mean that you need to rush out and pay to attend the most expensive school there is. And we all saw what over-reaching does in terms of a home…
While I think that it is okay to go into debt for college, people take college and its entailing debt too lightly. “I don’t know what I want to do and my parents want me to go” so I’m going to college. “I didn’t get a job right away or my dream job out of college so I’m going to grad school.” And finally, students are paying for prestige when there just isn’t the return on investment. Ultimately, there is a huge swath of young people who are saddled with punishing debt that will takes years to dig themselves out of.
I truly believe some life experiences are worth going into debt. The Wife and I went to Greece for honeymoon, and yeah we took on some CC debt for it – would I change anything? Absolutely not! Whens the next time I am going to get the opportunity to take 2 weeks off from work and see the motherland lol. By the time I saved up for it, I’d be out of “honeymoon” phase, and maybe with a kid or two.
If I said this on another blog which is based SOLELY on frugality I would probably get killed for it, but I think some peope here may understand.
I will take your start up business example and expand it to growing any business.
I grew up on a farm. Farmers have to borrow money to purchase land, to purchase equipment, to purchase the seed, fertilizer, chemicals, etc needed to plant and raise a crop. Its all a business decision. After they have farmed a while and are more established they may need to borrow very little if they have done well but if they want to expand then they need more land, more equipment, more seed,fertilizer,chemicals. So they have to borrow to expand. However if they are careful to take out proper insurance and not try to expand too quickly it can be done in a relatively safe way.
I would argue this is true for any business and I am doing it now with purchasing rental real estate. In the past decade we have seen examples of how people have purchased properties at inflated prices with 100% mortgages and simply hoped to flip them for a profit in 6 months as the market rises. This is using debt for pure speculation and is not wise. We have seen the consequences when things turn against you.
I am purchasing only properties that are selling for less than half of what they sold for 2 years ago, I am purchasing them with large percentages of cash down and they cash flow like crazy. If I would purchase them with pure cash only I could maybe buy 1 or 2 properties and then I would be tapped out. If I use responsible debt at very competitive long term interest rates I can change that to 8-10 and I can make very good profit on each one while renting it out and get price appreciation when things eventually improve which could be quite a while but since I am cash flowing each property by a very hansom amount each month, it doesn’t even matter if I ever get price appreciation.
If someone told me that was irresponsible or evil because I was using debt then I would argue they either don’t have any business sense of how to grow business wealth or they do it exclusively by selling their advice to others, none of which is likely to ever help any of them grow their wealth because their focus is on avoiding financial mistakes not on growing financial wealth. And plenty of people need the advice on avoiding financial mistakes, but for people who have that part figured out or never had that problem, making them live by the rules of those that don’t have that figured out is hindering and doesn’t actually make much sense.
There are basically two ways to use debt. One is to use it to live beyond your means. This is bad in almost every possible situation. (It may make sense on some limited basis like the commenter here who did so for his honeymoon but even then I would usually recommend against it). The other way to use debt is as an investment in something with greater future growth potential (education, business, job, etc, as you have pointed out here). These two uses have almost nothing in common with each other. The people who say debt is evil and should never be used are almost always focusing on and citing examples from the first reason for using debt. When they apply it universally to the second reason, they simply don’t understand what they are talking about.
This article is really about an employee perspective. Go to a good college, so you can get a good job, etc. etc. Isn’t this kind of boring? (I sense that finally some people are waking up, but still, this article doesn’t make any mention of another path.)
You also push the “buy a home for stability” line, which I also don’t agree with. I sit here typing this from a rental I’ve lived in for 5 years. Most folks don’t own their homes for much longer; the average used to be 7 years and has gone down in recent years. School districts are fairly large; I suspect that even if a rental didn’t work out, you could find another one in the same district. I strongly urge people to do the math before buying a house. If you can rent for less, rent for less and invest the rest!
I know my financial goals are far different from the majority of Americans. My goals include having enough passive income to pay all of my expenses. At that point, who cares whether I rent or own a house? If I have guaranteed passive income that exceeds my expenses, it’s a moot point.
I’d love to see other articles contemplating this viewpoint instead of more articles focusing on homeownership and career (yawn.)
-Erica
Erica,
Your comment is a good example of the idea that people can have different goals and different paths for reaching their goals. A college education can be about more than career placement, depending on the course of study and personal interests. I’m always happy to hear about people who eschew formal education and/or career path to develop their own path.
I honestly didn’t intend to bore you or make you tired enough to elicit a yawn, but I think this type of information and viewpoint applies to a lot of people in this country.
For the record, I’m a renter, too, for a variety of reasons, but that doesn’t mean I can’t understand what other people might desire or need.
Hi Flexo,
I enjoy your blog, and I also enjoy mildly teasing you whenever I see your common beliefs peeking out. All in good fun. I’ll continue to rabble-rouse in your comments. ;)
-Erica
P.S. Maybe I should sit down and write long enough to make some of this stuff into a guest post!
Erica,
I am trying to get to a similiar passive income point as you. However this is simply not possible for most people. Most people need a job/career. Not everyone can be a self sufficient passive income person. If so who would build the home you rent? Who would build the car you drive? Who would produce, process, package, transport, and stock the food you eat?
Self sufficiency is great to go after. I accept as fact that very few can do so and thus articles helping the masses to live smart in their jobs and homes seems reasonable to me.
Hi Apex,
Thanks for the reply! Actually, right after I wrote my comment, I wondered if someone would say that.
The answer to your quandary is similar to what Flexo mentioned in his reply to me — not everyone has the same goals. Who would build your house? Short answer: Someone who enjoys building houses more than he/she enjoys passive income.
Just because “everyone” can’t do passive income doesn’t mean YOU can’t. Don’t confuse the two, or you risk looping yourself into a defeatist position. Not everyone has to be the same. I act as a catalyst through my blog and these types of comments — I encourage people to think about the world differently. I like to shake things up. This post is full of common beliefs. I happen to subscribe to none of them.
There are plenty of ways to earn passive income. Many teach how to do it online, or you can learn value investing, or any number of ways…while still holding down a job, if that’s what you prefer.
Worth noting: If you believe that only a very few can do what you want to do, what are the steps you would have to take to become one of those few? (Side note: I don’t have that belief.)
-Erica
There may be a misunderstanding in what I said if you think I said because everyone can’t that I or you can’t. I am already well on my way, expect to be there in about 5-7 years. You may be doing great too. But it’s not that I don’t believe that very few could achieve passive income freedom, by definition, very few can. That is why I commented that I think the post is useful to the masses who are never going to leave the traditional mold.
Until such day as we can create machines that can provide us everything we need in life and have the means to spread all the excess around to the rest of us, it is definitional that most people must have a job doing something that would be considered productive. If you think there is a way for the majority of people to achieve passive income status I would love to hear how you believe the logistics of that works in our current economy.
Now perhaps I am misunderstanding you and you are saying that people can just do things differently than the traditional way but most would still be exchanging productive labor to produce goods in exchange for money but just under a different model than the traditional model. I accept that is possible. Some will do that. But no matter how much people preach alternatives, a significant majority will still follow whatever is the traditional model of the day and in our day thats the traditional job/career. You can call me defeatist for saying it but it’s been true for many decades and will be for many more. I would bet every single penny I have on it. Populations tend to follow normalized curves. Thats why they are used to analyze human behavior. And by definition normalized curves have huge lumps of people in the middle all doing approximately the average thing. Thats just how things work. But every normalized curve has two tails. You are focusing on the tails. Thats great, I am too. What I don’t expect is that I can invert the curve and force the lumps to the tails. There will always be those on the tails and you could “fatten” the tails up a little bit perhaps, but tails are what they are and they are never bigger than the body.
Now as to how I expect to be achieve different than the average … I already have. I live way below my means, save tons of money, have a very high networth and am purchasing income producing properties. All while holding a very traditional and well paying job as well as doing a business on the side that I sold off and am receiving residual payments from. And it was all a lot of work. I took the road less traveled, but it is vastly less traveled.
In no way do I suggest you can’t achieve your goal of passive income and that others can’t too. But the idea that the majority of people can break away from the traditional model of a productive labor job producing goods in exchange for money in our economy just is not achievable. You may not be arguing that but if you are I would love to see the logistics of how that works.
I’ve played the 0% credit card game, and as long as you’re diligent, you should have no problems. I always make sure that I pay the minimum payment a few days before the due date, just to be safe. Just make sure you invest the funds, and not spend them.
If you can guarantee that it will make you money in the long run! go for it.
But it must be manageable, Having $50K in debt for a degree in English does not pan out.
Buying a house that is over half your monthly income is foolish also. But people are still doing these things. Debt can work both ways just be smart about it.
I don’t know about you guys but I haven’t really looked back on the $33,000 of student loan debt I have and think, “Damn, that was a great decision!” In fact, quite the contrary…in this day and age a BA is now worth what a high school diploma was back in 1982.
For me personally, I don’t want anything to do with debt. I will be done with non student loan debt by the end of the summer and then I’ll need to start tackling my student loans. Once those are done, the only other debt I’m going to consider taking on is a 15-year mortgage and get that thing paid off as soon as possible…Maybe some people like “managing” a lot of debt to keep up appearances, or because they lack the discipline to save and wait, but that’s not for me. I like the idea of being debt free and knowing that money I make (after taxes of course) is all mine, not some banks’ or credit card companies’.
I like when people share the, “It’s ok to have a little debt, there’s good debt, this won’t hurt” kind of stuff. I hear that addicts say the same thing, “a little won’t kill me, I can manage or maintain this,” etc.
Prov. 22:17b “…and the borrower is servant to the lender.”
I would consider starting there, read those books, build your business to that passive income point.