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Counterpoint: Debt-Free Living Has Its Drawbacks Print
Sunday, 28th January 2007 (by J.D.)This article is about Choices, Debt
Yesterday I posted a reader comment on the virtues of a debt-free lifestyle. This prompted responses noting that debt-free living creates its own set of problems, and that responsible use of credit can be a valuable tool.
Greg C wrote:
Some people think credit = debt. It does not. Anyone who can budget can use credit the same as cash. You can also get credit cards and never use them. Millions of people somehow manage to do this. Sure going into perpetual personal debt is not good, [but] not all debt is bad.
Emily H wrote:
It is misleading to treat credit history as something that doesn’t matter. You can live without a credit history, but it’s hard. Maybe as hard as managing credit responsibly.
And jpsfranks wrote:
A lot of those advocating the no-credit approach are those who have had problems abusing credit in the past but who have now reformed. This implies they have some credit history, and if they tied things up well in the end, they probably have a decent credit history. If you have good credit but no longer use it, it may be misleading to tell folks with no credit that they don’t need it based on your own experiences.
These are excellent points. I concede that I am, as jpsfranks notes, a reformed credit abuser. My debts are not gone yet, but they soon will be. After that, I hope to live a debt-free life. But my existing (excellent) credit history will make things easier should I need to borrow in the future. Plus I’ll continue to carry a mortgage. It may be disingenuous for me to promote a debt-free lifestyle when I have an established credit history.
Meanwhile, a recent article from Smart Money, “Being debt free isn’t always all it’s cracked up to be”, echoes the same themes mentioned by Greg, Emily, and jpsfranks:
You’d think those who manage to be completely debt-free are living on easy street. That’s not necessarily the case. Living a debt-free life comes with its own unique set of challenges. After watching a debt-free friend be turned down by every mortgage lender around in part because of his lack of credit history, Leckband now reluctantly owns a credit card that he uses occasionally to keep his credit history active. The fear, he says, is that one day he may need a loan — the four-wheel drive on his 12-year-old car has gone kaput, making him worry that a car loan may be in his future — and he doesn’t want to find his options limited. “You’re expected to have debt to get debt,” he gripes. Some experts take this further, saying that living a debt-free life isn’t only potentially a hassle, but can be a big financial mistake.
Among the problems associated with a debt-free lifestyle, the article notes:
- Without debt, you have no credit history. Many lenders won’t grant mortgages, for example, to borrowers without a credit history. And usually those who will loan money in these cases do so at less favorable rates.
- Some debts are better than others. “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.”
- Debt-free living can create cash-poor situations. I confess to not fully understanding this point. The author seems to imply that you should consider incurring debt to subsidize retirement. This baffles me.
I have elected to pursue a debt-free life because I believe that’s the best choice for me. But it’s not the only choice available. Ultimately, the important thing is to manage your money responsibly. Whether or not you use credit, to gain wealth you must spend less than you earn.
[Smart Money: Being debt-free isn't always all it's cracked up to be]
January 28th, 2007 at 2:51 pm
I’m in the process of starting up a business, and I am suddenly very glad that I have credit history. I just have one card that I pay off every month.
I am not even trying to raise money from investors or take out bank loans - just opening accounts with vendors so that I can be invoiced instead of paying up front for everything. And if I do need a loan or credit line in the future, I know that it’ll be there for me. I am very glad I never got rid of my credit card, as I’ve been tempted to occasionally.
January 28th, 2007 at 3:29 pm
Well, I think your post points out something not everyone is catching: there are different kinds of debt. I’m of the belief that credit card debt is bad and should be avoided at all costs. However, home loans, car loans, etc. are acceptable forms of debt (maybe because of their lack of likely-hood to be abused for impulse purposes). And when you say that you are heading towards a debt-free lifestyle, but then talk about how you will still carry a home mortgage, I think that is confusing.
Isn’t there a separate name for credit-card-type debt? Maybe you should instead say that you will be leading a life free of THAT?
January 28th, 2007 at 3:55 pm
“Debt-free living can create cash-poor situations. I confess to not fully understanding this point. The author seems to imply that you should consider incurring debt to subsidize retirement. This baffles me.”
I’m not sure what the author means either but I can suggest:
If you spend your entire saving to buy a car instead of borrowing, then you might not have money for unexpected expenses like medical bills.
Also if you borrow at 6% to buy a house, rather than pay off the mortgage early you can invest extra funds for retirement in a stock index fund expected to return an average 10% a year over the long term (30 years). Spending money to pay off the mortgage early is like investing your money at 6%. It is usually preferable to invest at 10% rather than 6% when you can.
Conversely, living with high debt can create a cash poor situation too. If you buy a big house with so large a mortgage payment that you don’t have any money left over for other expenses you are also cash-poor. The house might appreciate more than a smaller house but all that money tied up in a non liquid asset doesn’t help you pay the doctor bills.
January 28th, 2007 at 4:05 pm
Another way to look at it is: taking out a mortgage at 6% and investing for retirementat 10% is like borrowing at 6% and investing the money at 10%.
Subsidizing retirement might also mean a reverse mortgage.
Also, a mortgage can allow you to purchase a home that you otherwise couldn’t buy. By the time you retire the home will probably appreciate and so you may have a lot of money for retirement you can access by selling the house and moving into less expensive housing (ie in another area or a smaller home).
Lastly, when you consider the tax deduction for mortgage interest the 6%/10% example becomes even more compelling.
January 28th, 2007 at 4:10 pm
Subsidizing retirement - Also consider the leverage you get when you put down 10% on a $100,000 home. If it appreciates 5% a year you put down $10,000 and you make $5,000 the first year. That’s a 50% return on your investment. It’s hard to find a better deal than that, (especially if you can invest the other $90 at 10% and get $9,000).
January 28th, 2007 at 7:06 pm
I think that there are two distinctly different groups of people that we need to discuss whenever we’re talking about credit card debt or unsecured debt of any kind. There are those of us who will treat our credit lines as if it’s money in the bank and spend up to the credit limit, and there are those of us who will use credit cards as a cash-flow tool only, and pay off our balance at the end of each month.
For the latter group, a credit card and a debit card are equally appropriate. For the former group, easy access to unsecured open-ended debt (credit cards) is dangerous to their financial health. For this group, it’s a BIG improvement to live debt free.
Worst option : Drowning in debt (and maybe adding to it!)
Better option : Debt free
Best option : Responsible credit user
As a recent article on GRS pointed out, some of us are more likely to be responsible users than others. If any person has a history of mis-using debt, then debt free is the way to go. For those of us who are capable of using debt wisely, either option (responsible credit use or debt free living) works.
January 28th, 2007 at 8:01 pm
Hmm … debt free lifestyle it’s a very attractive concept that would mean a large majority of your income would be yours to keep, because you wouldn’t be restricting cashflow because you’d have no mortgage debt or personal credit debt payments.
However, I would find it hard to believe that a person could afford not to get into some “investment” debt which creates an appreciable asset that can provide income and capital growth.
One of the main principals I feel that are imperative to creating sufficient wealth in your lifetime to retire when you want is to BORROW TO INVEST, as opposed to BORROW TO LIVE. By gearing/leveraging into an investment you will access potential capital growth that would be otherwise unattainable.
January 28th, 2007 at 10:32 pm
BigBuddha said: “One of the main principals I feel that are imperative to creating sufficient wealth in your lifetime to retire when you want is to BORROW TO INVEST”
I guess I’m pretty conservative in this area, but other than buying a house I’d prefer not to borrow to invest. People talk about taking out 2nd mortgages (or not paying extra on the first mortgage) so you can invest and make 10% over the long term. However, I’d much prefer to get the solid 6% from making extra mortgage payments than to gamble that I’ll get 10% over the long term. The problem is that the ‘long term’ could be quite a ways off and in the short term you could have some sort of emergency which requires you to take the money (borrowed money that you’re already paying 6% on anyway) out of the market at a loss.
A lot of people ‘borrowed to invest’ just prior to the great depression and it wiped them out. All this talk about borrowing to invest makes me nervous.
January 29th, 2007 at 2:32 am
I’m agreeing in general with the point that credit and debt are not the same thing.
If I was a lender and an applicant didn’t have a credit history, I’d assume that they think that they can’t use credit responsibly (from my point of view). That is that they would default. I have no evidence to the contrary.
Credit is, in concept, an extension of trust, and your credit history tells about how you much you have been trusted and how you have used (or abused) that trust. I can see why it is used such a lot and is important (but almost never life threateningly so).
If you truly wanted to be debt free and a good credit history then you need to show that you do indeed have self-control in your use of credit. You can even do this by pre-loading your credit card.
Living debt-free doesn’t imply not having credit. It implies not using it.
January 29th, 2007 at 4:59 am
I think what’s being confused here is the goal of attaining a debt-free lifestyle, and being entirely debt-free for your adult life.
Most people will strive to become debt-free at some point in their lives; ideally, this will be prior to retirement. My only debt at the moment is my mortgage, which I’m aiming to pay off by the time I’m 40. I still have other forms of credit, however (a credit card and a line of credit), but my credit card is paid off every month, and I rarely use the line of credit. In my situation, when I reach the point of being “debt free”, I’ll still have an outstanding credit rating, and be able to acquire new debt if I choose to do so, without problems.
Someone who tries to live a debt-free lifestyle from the beginning will not be likely to obtain a mortgage, and they may have other difficulties, such as not having a credit card to check into a hotel (I’m not sure if a debit card can always be used for that purpose).
In any event, the best of both worlds is to become debt-free as soon as possible, but to still maintain some credit, even if it’s not used often.
January 29th, 2007 at 6:11 am
When I think of bad debt I think of unsecured debt (i.e. credit card debt, student loan debt, etc.) I don’t want any unsecured debt although we plan to keep at least one credit card after all debt is paid off to maintain credit score (we have 2 or 3 small automatic payments that are charged to that one credit card [under $100] which is paid in full each month). Student loan debt is generally thought of as good debt but unless you are radically increasing your salary post MBA I’m not so sure its good.
Secured debt (i.e. mortgage on primary home or on investment home that is appreciating) is good debt, but still debt that I want to pay off.
I think of car loan debt as not so good secured debt b/c the car is generally losing its value.
January 29th, 2007 at 6:45 am
It is possible to get yourself into a situation where you have no debt, yet you are financially insecure. It’s also possible to get to your ideal body weight in an unhealthy way. That doesn’t mean it’s bad to strive to be your ideal body weight. You just have to be intelligent about it.
Our goal is to be debt free. The only debt we have is our mortgage. We haven’t borrowed any money in 4 years and we’re not planning on every borrowing again. We have cash saved for my next car, for example. We’ll never need to get a mortgage again, so we’re not worried about our credit score. We intend on paying for my kids’ college with cash. We have 6 months of living expenses in an emergency fund. We have substantial retirement savings even though we’re only 37 and 35. By the time we are in our mid 50s we’ll have zero debt and considerable assets. Without debt, we’ll be able to do whatever we want.
In our situation, I can’t think of scenario where borrowing money would help us.
January 29th, 2007 at 8:09 am
I was going to post about how misleading the idea of debt is to the spend-thrift (extreme) or frugal (extreme)person, but George nailed it. Credit rating services want to see someone who properly handles credit. Budweiser would like you to drink responsibly. Las Vegas would like you to gamble responsibly. They all really would, but poor impulse control people, or those that think the sky is always about to fall cannot understand the fine art of living.
January 29th, 2007 at 8:12 am
I have found it is useful to not euphemise things. I try to not use the words credit or debt and instead refer to it as “selling my future earnings at a diminished value.” As long as your interest rate is greater than inflation (which it almost always is) you are getting a bad deal. Living on cash allows you to reevaluate the costs and values of things you buy.
January 29th, 2007 at 8:20 am
Seth wrote “I try to not use the words credit or debt and instead refer to it as “selling my future earnings at a diminished value.”
It’s funny, a friend of mine who is remarkably nonchalant about debt looks at it this way: when you need more money than you have available, you buy some. Interest is the cost of that additional money. When he needs (or wants) to buy some money, he shops around for the lowest-cost money he can find (i.e. the loan with the lowest interest rate) and he calculates how much he’ll have to pay for it, which means that with credit-card purchases he sets himself a time horizon over which he’ll pay off the money he’s borrowed. I’ve argued with him that debt in and of itself (setting aside the issue of interest) has a cost too, since he could be investing that money and earning interest on it instead, but he dismisses that idea because he knows he wouldn’t have invested it anyway. I’m not recommending this philosophy by any means, but I thought it was an interesting way to look at it: you buy money and the interest you pay represents the cost of that money.
January 29th, 2007 at 10:25 am
Seth wrote “As long as your interest rate is greater than inflation (which it almost always is) you are getting a bad deal. Living on cash allows you to reevaluate the costs and values of things you buy.”
I couldn’t agree more. For people that can budget to pay off their credit cards, they can get an interest rate of up to -5% on some purchase and -1% on most others. My credit card is giving 5% back at gas stations, grocery stores, and drug stores.
So let me get me get this straight, you are going to pay me 5% to take your money for the short term. I think I have to take advantage of that.
January 30th, 2007 at 4:07 am
I suppose for some that already have a great credit rating, enough income to pay off credit card debt in full within 25 days while earning rebates and earning interest while still investing and growing their money - living their dreams then… a completely debt free lifestyle seems inefficient. For the rest of us - a goal of living debt free while living your dreams keeping us motivated to keep working on it, every day.
January 30th, 2007 at 7:40 am
Possibly a useful trick for helping to manage your credit spending: Split the card. Your credit limit is a pool, and you can allow multiple people to draw from it, and you can allocate it to multiple seperate cards. So maybe take a hundred dollars (or whatever amount you’ve budgeted) and put it onto your “John Doe” card, under your name. Put the rest onto your “INVALID John Doe” card, under and cut that one up. (Assuming your name is john doe)
I stumbled across this while looking at ways to restrict my exposure to internet fraud. Cheers.
February 1st, 2007 at 9:03 pm
23h12rjuh12 says:
Another way to look at it is: taking out a mortgage at 6% and investing for retirement at 10% is like borrowing at 6% and investing the money at 10%.
”
———————————————-
That’s not another way to look at it. that’s the same way.
Consider:
———————————————
10% on a $100,000 home. If it appreciates 5% a year you put down $10,000 and you make $5,000 the first year…that’s a 50% return on your investment.
——————————————–
No you don’t, unless you skip out on all your payments, but are still allowed to live there. Your montly payments (not including PMI, for less than 20% down) is around $7000 per year at 6%. So in year 1, you paid $17k, not $10k.
Anyways, your investment is $100k. That’s your mortgage. $5k on $100k is around 5%. that’s assuming you could sell for $105 with no closing costs. God, Robert Kiowasaki is gonna kill people with his bs math. I know that’s where you got that from.
Assuming you had $100k to either buy a house or invest in a money market (from a money-only standpoint), i’d take invest, because a money market will get you 5%. Most years, the stock market will get you more.
That’s also completely ignoring the fact that you can borrow money to buy stocks, the same way you can with a house.
Also, your total interest outlay over 30 years would be $100k, so for a $100k house, you paid $200k in total. better hope it doubled in value. at 5% gain per year, you’d be in the hole, because your interest was 6%, remember?
Finally, unless you had other deductions (kids), at 6%, the standard deduction would be pretty much the same as interest, so there’d be no real gain there.
In terms of those who are debt free, “cash poor” refers to the old timey notion where things had to be paid for in cash, or you couldn’t leave. in these days of home equity, credit ratings, and lines of credit, its not a problem anymore for those who are debt free. they are probably decent at money management, and can handle an interest payment if one is *required* for medical or a family emergency.
However, the greater risk for those who are debt free, and got there by being frugal, is not being “cash poor”, but rather being under insured for when situtations arise that current cash can’t cover, like medical emergencies. make sure you aren’t neglecting insurance needs to squeeze a bit more out of your paycheck.
February 1st, 2007 at 9:13 pm
Credit rating services want to see someone who properly handles credit.
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i also disagree with this. the credit rating industry is the evil behind the curtains here. you know your value as a credit card customer - it’s printed on your bill with your interest rate and credit line, and if you don’t like it, you can cancel the card or pay it off. you can also calculate your interest to make sure they aren’t cheating you.
You can’t calculate your credit rating - the formula is proprietary. you can’t leave - there’s only one that everyone uses.
it’s not advertised — you have to pay to see it. to fight mistakes involves notarized forms and freight mail, not 1-800 numbers and cajoling some person with a crappy job.
finally, the default difference between a good credit rating and a bad one is only around 2%, so the rating agencies tweak their formula to make it seem bigger, and more valuable, than it actually is. and the consumer is the the loser.
February 3rd, 2007 at 12:16 pm
Modern debt is akin to slavery. Your credit card master determines the terms of your relationship and those terms can change at any time. And, borrowing to buy an alledgedly appreciating asset leaves you illiquid and beholden to market forces outside your control. The idea that mortgage interest is good because it’s deductible is hogwash. The tax law just contributes to the overpricing of houses.
February 7th, 2007 at 9:38 pm
I don’t think most of your realize what debt free living really is. That means no debt and you do not have to worry about credit because you pay for anything when you buy it, whether cash, check, or debit card. If it is all your money I promise you will make sure you have done your homework and have gotten the best deal. When you are debt free completely then you can build up a cushion for decrease in income (we have gone even 75%less) and able to insure for big disasters. Living on less isn’t always the easiest, but it is easy on your mind with a huge reduction in anxieties or worries. Debt-free for real for 16 years and loving it.
May 17th, 2007 at 11:46 am
Ten years ago my credit card debts were wiped out in bankruptcy. Over that time I have lived debt-free and have managed to save in excess of $60,000. I retired from a government job at fifty-three, investing my pension account into a life annuity, because I have learned how to live cheaply. I lack for nothing I really need and continue to save about $500 per month. I expect to have over $100,000 in savings by the time I am eligible to collect SS benefits, at 62. This isn’t rich my any means but I feel quite comfortable. I only wish I had lived as prudently much earlier, and NEVER accumulated even a dime of credit card debt. I would be much better off.
October 5th, 2007 at 12:37 pm
My understand of being debt free was allways not having consumer debt not having credit cards. My Dad has been debt free since his early 50s (he’s know almost 80) yet he’s always had a credti card. Perhaps we should clarify what we mean.
Debt free means not having consumer debt, not, not having a credit history.
October 5th, 2007 at 1:10 pm
Debt-free living definitely has its drawbacks. I recently got married- I was deeply in debt (cult escapee, don’t ask), he wasn’t. I had student loans, house payment, HELOC, 3 credit cards, everything nearly maxed out. No late payments, but clearly not a smart credit user. He had $0 debt. When we just recently refinanced the HELOC to a lower rate (combination of improved loan-to-value, and going to the local bank like I should have the first time), his credit score was dramatically lower than mine. It seems counter-intuitive, but we’re adding him onto my 8-10 year old credit card accounts to *improve* his score, so we’ll be able to buy land in a few years. Buy land, build a house to live in, rent out the house we currently own for additional income. (Yes, we’re aggressively attacking my revolving debt; we should have the credit cards paid off in the next year, the HELOC in the next 4 or less.) His lack of credit history would jeopardize that plan otherwise…
October 5th, 2007 at 2:14 pm
If you want to live without credit entirely, then that means two things: you are filthy rich or you have incredible discipline in terms of delayed gratification and detachment from worldly things.
Because I don’t know about most of you, but I’m not in the habit of writing checks for thousands of dollars.
Personally, my view is this. If you pay 0% interest on the money you borrow, then it is good debt. (Assuming of course, it makes sense to be buying the item in the first place.) If someone wants to give me money and not charge me for the time value of money then by all means. When I bought my last car, the auto industry was all with the 0% loans. You bet I took that loan. It’s about the only way borrowing money to buy a car (a fast depreciating asset) makes sense.
I view credit card float methods the same way. The trouble with them isn’t in the fact that you have borrowed money for a month, but in lacking a budget discipline. If you only spend the bills in your wallet, then how much you put in your wallet asks as a budgeting checkpoint. The problem is that putting credit cards in your wallet can be like slipping in a few dozen thousand dollar bills. If you don’t have any other budgeting disciplines in place, you can end up in a world of hurt. In fact, I try to tell people who have multiple cards (and admittedly I don’t follow my own advice always) to not carry all of them with them. That’s not to say you can’t get into a world of trouble with the credit limit of one of them, but it at least reduces what’s available to you when you are actually at the point of sale.
I also view as “reasonable” debt (as in, it could make sense to carry it), debt that is associated with a transferable asset that has chances for appreciation. I view my mortgage that way. If you normalize my former rent with my now mortgage based on the differences in my living spaces, I think they are roughly equal. Sure, I don’t think it makes sense to view your primary residence as an investment vehicle. But I do have the advantage of knowing that I will recoup my “rental” expenses, the loan’s true cost is reduced by the tax breaks, and if I live hear long term I may have achieved lower living expenses for retirement times by owning outright. If things ever got real bad, I could sell the house.
I have to agree with some above about student loan debt. No doubt, the studies show that advanced degrees can significantly boost earnings. But the problem is that it isn’t a transferable asset. I can’t sell to you my degree to pay off that student loan. I could do that with my house. In that sense, I try to advise people to know what they are doing before they take out significant student debt. Because the debt load may force you into job choices that you discover you wish you didn’t have to make on the basis of what can cover you debt obligations.
January 18th, 2008 at 11:01 am
[...] than $100 in interest over that short period of time with no missed payments. If I had had poor or no credit available this move would have been a lot more difficult to [...]
June 11th, 2008 at 2:43 pm
All of these “negatives” about not having debt are based on the assumption that you’re gonna have to aquire debt. Mortgage, auto loan, personal loan, etc are all debt! They may be considdered more “responsible debt” than credit cards, but it is debt nonetheless. If you need/want to buy a house, why not save up until you have the money to buy a house? If you need a car, save until you have money to buy a car.
These are the principles that my (lived through the depression) grandmother taught me as a young child, and every time I’ve ignored them, I went wrong.
The only situations I’ve encountered where it was difficult to deal without credit were in having to pay a higher deposit for utilities, cell phone, etc. These are managable figures that have run less than $175.
Oh, and btw: I’m not rich, my partner and I make about $12K a year combined. It’s not impossible, and it doesn’t take insane willpower, it just takes the belief that the world doesn’t owe you something you can’t pay for. And I don’t write checks for thousands of dollars. (Although this *is* normal!) Checks can and will bounce, and have even when my account had enough funds. I use cash. I write two or three checks a month when I need a paper trail. Otherwise, cash is what you need.
February 5th, 2009 at 10:30 am
A paid for home.., I see where investing your money to get a larger return is smart rather than putting this money toward the principal balance of your mortgage BUT peace of mind knowing that your home is all yours and not yours and the lien holders- wow! I’m 33 and bought my home with a 100% loan, I have come to my senses and I am eliminating debt productively- I love seeing the credit balance drop!! Credit is good but debt is bad. Everyone needs credit, open a credit card and don’t use it except to buy maybe $5.00 in gas every few months and pay it off. I analyze credit daily so this is good advice I feel. Good luck!!