Is Debt Dumb? Three Helpful Perspectives on Debt

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Personal finance gurus are always preaching that you should get out of debt. But what exactly is debt and why is it so bad?

The boring, simple definition is that debt is borrowing money. It’s paying later instead of right now.

But why is this bad? Let’s look at three definitions of debt that fly in the face of good financial sense.

Debt is Borrowing From Your Future Self

Usually we think of debt as borrowing from a lender, or a creditor. This is true, it just misses part of what is happening.

If you don’t pay for something now, up front, you’re future self is on the hook to pay for it.

This is an area where human beings always get into trouble. It is far too easy to discount the concerns of your future self when your present desires are at stake. Anyone who has ever tried to lose weight, beat procrastination, or develop new habits knows this all too well.

No One Negotiates a Pay Cut

“Think of borrowing money as negotiating a pay cut with your future self”

Preet Banerjee

Let’s say you really want an expensive new phone instead of making do with the one you have. You don’t have the money, so you buy it on a credit card and make the minimum payments.

The fact that you only have to make a small payment every month is what makes this seem appealing. No one likes seeing $1,000 vanish from their bank account in an instant.

But now what has happened? Your future paychecks are all worth less because you have to pay the credit card bill every month.

You wouldn’t ever negotiate a pay cut, but you’re fine lowering your real rate of pay by tacking on recurring expenses.

The irony is that by the time you pay off the credit card, your phone won’t be the newest and shiniest anymore and you’ll want to buy another. And of course, you won’t have the money saved up because that money was all going to paying off the last phone (plus interest).

Debt is Signing Away Your Freedom

Here’s a principle that few people understand: The more financial obligations you have, the less free you are.

If my lifestyle costs $20,000 a year and I lose my job, I have lots of options. There are an enormous number of ways to come up with $20,000.

In fact, with a cost of living that low, there’s a good chance that I don’t even need to find a job immediately. The less money you spend, the more you can save for a rainy day. Not only that, but the money you save goes farther, since each dollar saved is a higher percentage of your total budget.

In the last section we talked about how borrowing money is the creation of an ongoing expense until the debt is paid off. Borrowing money increases your financial obligations. Obligations, by definition, limit your freedom.

It becomes even more of a tragedy when you realize that you’ve lost your freedom to be able to pay for stuff you’ve already bought. You’re sick of that stuff already. You want new, better stuff. Well, tough. Get back to work. Your credit card bills aren’t going to pay themselves.

Debt is Agreeing to Pay More Than Something is Worth

The other day I was at Jiffy Lube getting my oil changed. I overheard the cashier telling a customer about the new car he had just bought. $20,000 purchased on a 60 month loan at 5.19% interest with no money down.

Why this story struck me as funny is because usually people boast about how much money they save when making a big purchase: “Yeah, they were wanting $18,000 for it, but after two hours of playing hardball I got them to come down to $16,500.”

This guy bought a car that cost $20,000, but after interest is going to pay $22,750.

He must be a shrewd negotiator.

That might not sound like a big deal, but think about it like this: If you can’t afford something that costs $20,000, why would you agree to pay $22,750 for it?

In personal finance the smart strategy is pay less, earn more. Not earn less, pay more.

So is Debt Dumb?

Most of the time yes, debt is dumb. It doesn’t make your life better, it slowly enslaves you to let you buy things that you don’t appreciate five minutes later.

Of course, there is actually a way to use debt shrewdly. The only time when debt isn’t dumb is when you wisely apply the Golden Rule of Borrowing. But that is a lesson for another day. When it comes to buying things that you don’t need and can’t afford, yes, debt is dumb.

Matthew
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