Smart Money on How to Live Debt-Free
Monday, 24th September 2007 (by J.D.)This article is about Basics, Debt
Brad Reagan at Smart Money has advice on how to live debt-free. His article is really about how to get debt free, and it contains some useful tips.
Keeping your debt load as light and as cheap as possible is the key to a more secure future and to guilt-free spending on the things you need and want. It’s a skill that’s often neglected and seldom discussed, but understanding how to manage your debt will let you build wealth faster, and with less risk.
Disciplined saving and smart investing are the topics that get the most ink…but without a good debt strategy, the planning for your financial future can get awfully wobbly. The explanation comes down to Home Economics 101: Paying interest works against you in the same way that earning it works for you when you invest.
That last sentence is important: compounding can be your best friend, or it can be your worst enemy. The more you’re able to earn interest instead of pay it, the more you’ll get ahead. To that end, Reagan encourages three courses of action:
- Carry only as much debt as you need.
- Keep interest rates low.
- Strive to become debt-free as soon as possible.
The article encourages accelerated payments on all types of debts — including mortgages. It also advocates eliminating all variable rate debt — credit cards, adjustable-rate mortgages, etc. — and moving it to products with fixed rates. Read the entire article for more tips on how to live debt-free.
Compound interest working against you on your debts is EXACTLY the reason why you should NEVER invest borrowed money, or invest when you’re trying to get out of debt. In other words, don’t fund your 401k if you’ve got $10,000 in credit cards and a $15,000 car.
Likewise, debt on a house should be paid off as fast as possible, because that amount of interest you’re paying over time is huge. If I paid only my minimum payment for the 30 years on my mortgage, I’d pay twice as much as that loan just in interest!
@jtimberman, I disagree about the 401K, although I agree you shouldn’t be investing in non-retirement stuff before getting rid of your credit card debt.
If I didn’t in my 401K every month and instead put that money towards credit cards, I would be throwing away $2 for every $1 saved, because that is how much my employer matches.. Also, I would be missing out on probably several years of compounding, not to mention paying more taxes on my salary.
Now, my employer offers an excellent match, and not all do, but most will at least match you dollar for dollar.
IMO, not starting your 401K the very same day you start your very first job and sticking to it until the bitter end, is foolish, to say the least.
@icup: Dave Ramsey advises people all the time to stop investing in 401ks when their employer matches.
Why?
Because when they’re done with the credit cards and other debt, they freed up even more money that they can invest. His advice for retirement is to invest 15% of income like this:
- Company 401K up to the maximum % they will match.
- IRAs/Roth IRAs for the remaining %.
- If that maxes out the amount for an IRA/Roth IRA, but doesn’t meet 15%, then go back to the company 401K.
Becoming and staying debt free is the biggest key to financial freedom and building wealth. Investing money when you owe money[1] is foolish.
[1] Mortgages are ‘ok’ debt if you did it right[2], since you build equity by paying off the loan.
[2] Put enough down that you can buy the house you want with a payment that is no more than 25% of your take home pay, on a 15 year, fixed rate loan.
[...] from: Get Rich Slowly offers an encouraging post on living debt-free (…a key reason why Istanbul was let go; wow could I sound more [...]
I have been under the impression that paying off my student loan debt any more than I have to per month loses me money. My online savings acct. gives me %5.05 interest. My student loan debt is locked in at %2.62. Isn’t is counterproductive to pay off my student loan debt aggressively instead of saving and earning %5.05?
Bear in mind that we are also about to do down to one salary so that I can stay home with our children. I am socking away as much money in savings as I can so that we can have a nice cushion.
Don’t get me wrong- I would kill to get rid of this student loan debt. I have paid off both of our cars and have zero debt other than student loans (which are sizeable).
Followup - affording a mortgage was just answered by Dave on the Total Money Makeover site:
https://www.mytotalmoneymakeover.com/?event=displayFreeContent&intContentID=7717
Nobody needs student loans, therefore nobody needs student loan debt.
Personally, I’m getting tired of “live without debt” articles that are really “get out of debt” articles. Yes, it’s nice to see that people are thinking about it, but I’d be more interested in
* Do you really need a credit card to rent a car?
* Charge cards vs credit cards
* Why buying a car with cash means you’re a less desirable customer
* How to buy a home without credit
Of course, it may just be that I’m old, crotchety, and paid off my (consolidated) student loans 7 years ago. (Remember the bit about being old?)
JenK - I recently rented a car with a debit card (w/ Visa logo) and didn’t have any trouble. The rental car was both reserved and paid for with my debit card. My travel office (biz-related travel) confirmed that I could do so and told me that the rental company (Avis) might hold a certain amount of cash (called “blocking”) as a deposit but no such hold ever occured.
Well, if it was really an article about living without debt, the entire body of the article would be “spend less than you earn.” You can string it out a little bit for entertainment value like I did in my One-Step Guide To Becoming Rich, but that’s the bottom line. The way to live without debt is to not go into debt. It’s a tautology.
You could make some comparisons between the net cost/benefits of buying sooner with a loan vs saving and paying cash, but that’s not really a how-to. The how-to is “don’t go into debt, save.”
My life’s work is helping people get out of debt and I would much rather focus on keeping people OUT of debt to start with. But our society doesn’t help. Here’s a great little calculator that demonstrates that:
http://www.csus.edu/sfsc-ymm/04_credit_cards/buying_on_credit.html
It shows how you can make a $5000 purchase for your home and it will actually cost you over $6500 at approximately $18% interest, 3 years later.
I disagree with the don’t invest in your 401k until you are out of debt strategy as well - if you have an employee match it’s free money. Of course if you’re investing in your 401k and can’t pay your other bills to get out of debt, then that might be a different story, depending on where else your money is going.
I pretty much don’t follow Dave Ramsey then.
Maybe he means don’t max out your 401K after employer match until you are out of debt? I can agree with that. I just can’t see how literally refusing to accept $300-$500 a month is sound financial advice, even if you have to put $150 in the bank to get it.
This of course is just my perspective.
@jtimberman et. al Re: Ramsey
Ramsey is speaking specifically to people who can get out of debt within 2 years or so. If one can do that, then he thinks they should put every resource into it, including ignoring the free money just to get free.
On the other hand, for those who can’t get through with 2 years of gazelle-like intensity (me, for example, who won’t even earn in the next two years what my husband and I owe), he does recommend putting some into 401(k) or savings. Because we’re going to have to live intensely, frugally, but we also have to build for the future. Paying off the debt may take 5-10 years. (mine’s $119,000 that’s not my own.)
I don’t remember the page in Total Money Makeover, but he talks about it in there. He just says that most people who get intense actually can pay it off within the 2 years or so if they’re willing to commit to his program.
@jtimberman
Just because Dave Ramsey says it, doesn’t mean its a good idea.
@Mrs Micah
I haven’t actually heard this nugget of advice, but I can see why its a good one psychologically (which is how the whole Dave Ramsey thing works). You will probably lose out financially by not contributing to a 401(K) with a match, but over only two years, its not such a big deal.
@jd
I’m hoping that you’ll be out of debt really soon, so that you can write some stuff on the next step - about living debt free. I need some inspiration.
I agree with plonkee. I’m about to make the last credit card payment on October 15th, and I would love to hear more about staying out of debt. Yes, obviously, spend less than you earn, but I’m looking for a little more detail. Right now I’m just planning to go into serious saving mode after I’ve mailed the last payment.
I’m not sure what sorts of secrets you’re looking for. If you’ve managed to dig your way out of debt, then just keep doing what you’re doing. Keep living frugally, keep budgeting or tracking expenses, keep making automatic withdrawals when you get paid. Except that instead of paying down debt, you put that money into savings.
I haven’t been in debt in years and was already out when I started getting interested in personal finance. But aside from a few specific techniques like the debt snowball or debt consolidation, everything that applies to getting out of debt also applies to saving. JD may talk about using various techniques to pay down debt faster, but the techniques work just as well for building up your net worth.
It’s like using a hose to fill your swimming pool rather than fight a fire. All the steps to hook up the hose and get the water running are the same, but instead of pouring it on the fire you pour it into your pool. Which in this case is a pool filled with money.
plonkee, I’ve been debt free, but for the mortgage, for about a year. One of my most recent motivators is signing up at the networthiq site to track my net worth.
I had never taken the time to really put it all down on paper before. So, now besides looking forward to paying off the mortgage, I look forward to my monthly accounting to see if I’ve made progress toward my ultimate goal of financial freedom.
I wish I had signed up much earlier to give myself credit for having dug out of that pretty big debt hole. It can be easy to forget how much progress I’ve already made.
Sam,
You’re not the first person I’ve heard from who used debit cards to rent cars (sometimes with a block, once where the block resulted in bounced checks). I’ve also heard from others who had debit cards refused. (When traveling for business. For Microsoft.)
I’d like to see a round-up of company policies, so that I’d know - for example - that company X takes debit but company Y won’t.
Personally I prefer not to use a charge card for that sort of thing. But that’s me, and we all come out on different places on the risk assessment of debit vs credit vs charge
April & Plonkee - I would suggest that you build an emergency fund, if you don’t have one. The emergency fund is a big part of staying out of debt. It’s the money you have on-hand to fix the furnace when it dies, pay the deductible on your car insurance, or to keep paying the mortgage after you’re laid off. Having money available is huge.
Ours is pretty big right now - 6 months’ living expenses - because we don’t feel very secure in our employment. Some of it is in the savings account at our credit union; some is in a money market at Vanguard; the rest is in a short-term bond fund at Vanguard. (Both Vanguard accounts have check writing privileges.)
[...] Peace of mind means debt free (getrichslowly.org) It’s nice to become an overnight millionaire, but that’s more the exception than the rule. In the ain’t-it-the-truth blog, getrichslowly, J.D. offers advice on how to become debt free and stay that way. [...]