The 10th Man

Debt Is the Enemy (Part 1)

August 2, 2018

Ever build one of those mortgage spreadsheets? Take your interest rate, the term of the mortgage, your payment, and plug it all into a spreadsheet to see how it amortizes over time?

It’s a pretty good exercise. Here is the key step—open that spreadsheet and add up the interest you will pay over time, assuming you don’t make any prepayments.

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The answer will probably blow your head off.

For example, on a $250,000 30-year 4% fixed rate mortgage, you will actually pay about $430,000 in total over the course of those 30 years.

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Every butthead reading this is like, “But you get to deduct that from your taxes!”

I have never understood that philosophy. You would rather pay more money than less money so you can get some of it back?

True, mortgage interest is tax-advantaged (for the time being), but most of the money you pay in interest is unproductive. It doesn’t do anything. That is the price you pay for the ability to spend money you don’t have. And it is expensive.

If you pay your mortgage dutifully, you are a good customer of the bank. You are making a banker rich. Who wants to make a banker rich? Or worse, some giant faceless corporation?

Don’t be a good customer of the bank, be a bad customer.

Prepaying a mortgage (especially if interest rates fall) puts the bank into a pickle—it has to decide whether to reinvest the money at a lower rate of interest. This is known as reinvestment risk.

Credit card interest, also unproductive. Car loan interest, unproductive. Student loan interest, unproductive. Who has ever been happy about the hundreds of thousands of dollars people pay in interest? Think of all the things you could have bought with that money.

Nobody thinks about this.

It’s just a fact of life that you have to have a car loan, a mortgage, credit card debt, and other forms of debt. It’s the American way, man, get with the gosh darn program. (I’m being sarcastic. You don’t have to have any of this debt.)

I’m with Dave Ramsey on this—you don’t have to have a car loan. I’ve had two car loans in my life, both through USAA.

The last one was 4% and I paid $8,000 in interest over five years. I wasn’t happy about paying $8,000 in interest. I thought there were other things I could have done with that money. I took the loan because it was offered to me—I didn’t put a lot of thought into it. And then I had 600 bucks going out the door every month.

Debt is bad. The interest you pay is unproductive. It is flushing money down the toilet. Flusssssshhhhhhhhh.

The Worst

Credit card debt is the worst. Of all the years I have had credit cards, only once did I carry a balance for a month. I was just curious to see what would happen. I got charged $50 in interest is what happened. Welp, that was fun.

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There are people who carry tens of thousands of dollars (or more) in credit card debt and pay the monthly minimum, incurring hundreds of dollars of interest charges every month. Talk about being a good customer!

I do not understand why someone would limp along like a cancer patient under the crushing burden of all this debt, and not take any action to get out from under it. Bankruptcy is obviously an option, but a better option is to implement some austerity, start saving money and chip away at those credit card balances. You can get it to zero over time if you work at it.

Credit card debt should not be used at all. Of course, credit cards also are a medium of exchange. You can pay for pretty much anything with a credit card nowadays.

Mr. Ramsey advocates going without credit cards altogether. I disagree. Being part of civilized society means you have to have a few credit cards to pay for stuff. Ramsey infantilizes you and says that you cannot be trusted with it. I say that you can—it just takes more discipline. Pay that sucker off every month.

Some people like to use credit cards for “emergency expenses,” but I don’t think that is such a hot idea. I think a hotter idea is to carry lots of cash (see last week’s issue) which can help you absorb any unforeseen expenditures. If you get hit by a cement mixer and you put your medical bills on a credit card, that will accumulate interest. And I suspect that slug of debt will become a permanent feature of your finances.

As for the points and the rewards, eh. They’re not that big of a deal. Most people don’t spend enough to get anything good, and those points/miles expire pretty quickly. People can be greedy about accumulating points, but very few get around to using them1.

If you have a balance, pay it off. If you have multiple balances, pay them all off. You should pay them off before you pay off your other debt because you are getting violated by the interest rate.

You have to take action. Leaving those bills unopened on the counter doesn’t mean this is all going to go away.

Brief Interlude

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The money you pay for it is not what I would characterize as unproductive.

One Last Thing

The number one question I get as a financial writer—

--I mean the number one question—

“Why should I pay down my mortgage/car loan/credit cards? I can earn more than that in the stock market.”

Uh, no, you can’t.

Even if the after-tax interest rate for your mortgage is below 3%, there is no guarantee that you will be able to beat it.

All you will have done is swollen your balance sheet, with lots of assets and lots of liabilities. Shrink the balance sheet. Make it smaller.

It’s about safety. Once you own your house/car/life free and clear, there is no better feeling in the world.

The stock market may not behave. Then you’ll have debt and losses. Take care of the debt first—after that, start looking at making money in the stock market.

Freedom

Think of the thousands of dollars you have going out the door in debt service payments:

  • Mortgage
  • Car loan
  • Credit cards
  • Student loans

Some of this debt is “better” than others, but it’s all bad. Imagine you got rid of it all, and you had your income—all of it—turn into pure, free cash flow.

Is that even possible?

Next week, I will tell you that it is.
__________
1 I get a free trip to Vegas from credit card points every year (flight and hotel), but that’s not something you should strive for.

Jared Dillian
Jared Dillian

 

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alovchik@hotmail.com

Aug. 2, 4:18 p.m.

Wow, this is the exact same financial philosophy I have used all my life. It has served me exceedingly well and I have never “done without”, as I always had accumulated enough cash to purchase my “wants” without debt. Saving and paying cash helps focus and prioritize what your “wants” truly are.
I actually have two outstanding debts currently. One was from a furniture buy that offered 5 year free financing, but no discount if I declined the offer. Hey, nothing lost, with “interest free” debt for 5 years. The second debt is for a new car purchase which I financed with USAA for 0.99% interest for three years. I have definitely earned more interest with my 1.9% online savings account, plus I figure it will boost my credit report with the added good payment credit history.

Jim Johnson 34645

Aug. 2, 3:44 p.m.

The really nifty thing about paying off the mortgage is having payment money there to save, invest, dump on the kids—whatever.
Over the years our expenditures have switched from needs to wants.  Shelter is a need hence a plain Jane house with small functional bathrooms and appropriate sleeping space satisfies the needs.  Those wants like granite countertops, luxurious baths, curvy staircase, massive covered porch are not really necessary; so why pay for them just because your income can cover the monthly payment?  You just gotta have some bucks left over for the golf course, airplanes, boats, travel and kid’s expenses. 
About the only way one can be freer then out-of-debt is to be free of the grids (power especially) as well.  Paying recurrent bills on the CC (you only use one, right?) seems safer than debiting the checking account.  But it is a monthly payoff.  If you would really see your accounts swell, get off that 2 pack a day smoking habit and ease up on the good hooch.
jj

benjamin.t.roberts@wellsfargo.com

Aug. 2, 1:46 p.m.

Sorry, Jared.  I like your commentary and analysis, but your math was wrong regarding the mortgage.

For a $250k mortgage on a 30-year fixed rate loan, your P&I payment will be $1,193.54.  That leads to a *total* of $429,674.40 paid over that period of time.  The interest paid ($429,674.40 minus the principal amount of $250k) is only $179,674.40.  Your error made it seem as if the interest was ~172% of the principal amount, when it was only ~72%.

While that’s not chump change, it’s also much more comparable to investing in a bond at 4%.  A guaranteed return of 4% may not be a bad return in comparison with other fixed rate investments, but you’re also giving up the liquidity in exchange for it (since you can’t recover your principal / equity until you sell the home).

As others have noted, the fundamental question is whether you believe you have a sufficiently higher expected rate of return on any investment to account for the level of investment risk minus the liquidity cost of “investing” it in paying down the mortgage.

Otherwise, I agree that holding credit card debt (at interest rates of 9%-24%) is simply foolish.  That should be the first thing to go, and people should avoid it at (almost) all costs.  They certainly can’t get a fixed rate investment elsewhere at that rate of interest (and maybe not even an equity investment, depending on the rate), so it’s not even a contest.  If you pay it off each month and avoid the interest / finance charges, then it may not be so bad.  However, maintaining a balance is a terrible idea.

ceyre@ihmcloans.com

Aug. 2, 11:40 a.m.

Mortgage interest would be around $180K with total payback (including original principal) of $430K.  The car loan at 4% with a $600 payment for five years would total less than $4K in interest paid…good points in the article, but incorrect math

Nick Polydoros

Aug. 2, 9:57 a.m.

Have to disagree about the credit cards.  Everything goes on the credit card.  For example, doctors office sends blood test to out of network company.  Call insurance company and they cover the bill and send us a check.

Charge $2250 to Capital One credit card which gives reward of 2%.

End up making $45 and have use of the money for a few months.

Robert Dvorak

Aug. 2, 9:33 a.m.

You’re wrong on one thing.  The whole decision is about the interest rate.  If they want to give me a 0.9% car loan and I can get 1.5% in a Money market or CD, there is zero reason to not take the money. Why give up that opportunity cost by losing the spread. So, it comes down to risk of making that interest rate.  A money market or CD is what most people would call risk free.  I agree that a Stock earning a yield over your loan interest rate is not risk free and thus you should factor in the risk associated with investing the money vs paying off the debt.  However, there is no way to earn a risk free rate to match a credit card debt, so pay it off.


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