Last week I talked about how interest can be one of the greatest wealth inhibitors/creators in life. The best way to make sure that interest is not a wealth inhibitor in your life is to avoid/eliminate debt. As I have mentioned numerous times the goal of frugal living/financial independence is freedom, and debt is one of the greatest inhibitors to freedom. Websters 1828 Dictionary says it best in its definition of debt. It defines debt as, “That which is due from one person to another, whether money, goods, or services; that which one person is bound to pay or perform to another; as the debts of a bankrupt; the debts of a nobleman. It is a common misfortune or vice to be in debt
When you run in debt you give to another power over your liberty.”
Debt literally robs you of your freedom and somehow society has been convinced that this is just the normal course of events. Debt keeps you chained to jobs you don’t like because you have to make a payment each month. Debt doesn’t allow you to take a vacation because you have to make a payment, debt keeps you stressed out because you are worried about having enough to get through the month and still be able to make a payment. Well, as someone who is debt free, minus investment mortgages, I am here to tell you this does not have to be the case.
I feel it necessary here to have an aside to discuss the concept of good vs bad debt which I believe exists, though it is a highly debated topic. Good debt is debt that increases your income or net worth. My investment mortgages definitely meet this criteria, but the loan payments are also covered by the renter, so not a burden on my position. Some would argue that student loans, home loans, and car loans also fall into the good category. I highly disagree that car loans are good debt as you are buying a depreciating asset and there are numerous other options to achieve the same purpose. I see a home loan as a necessary evil, though do think we go about buying homes in the wrong way and will discuss in an upcoming post. I feel similarly about student loans in that there is not enough intentionality when people take them out as society has been convinced it is just the way of the world. Bad debt is debt going towards depreciating assets or debt that does not increase your net worth or income. Examples of bad debt include credit card debt, payday loan debt, etc.
The reason I covered interest in my last post is because I believe it is greatly overlooked when people view their debt. Debt/interest is not only robbing you of your freedom, but also your money. I have heard so many people through the years say things like, “Oh yea, I got this new car for $25,000 when the dealership wanted 32.” or “I only have $3,000 on my credit card, it’s not bad.” The only way you got the new car for 25K is if you paid for it in cash, or you had a 0% interest loan. If you put 5K down on the car and took out a 72 month loan at 4% interest for the remaining 20K you end up paying $2,529.12 in interest. That’s a nice vacation you are giving up for the “privilege” of borrowing money. With the credit card, I admit $3,000 doesn’t sound bad, especially when the average for an American family is $10,000, but if you were to put no more charges on that card and pay $75 a month with the card having a 17% interest rate it would take you 60 months to pay off the debt and you would pay $1,458 in interest. Were the items that you were willing to pay $3,000 for worth actually paying $4,458 for?
Hopefully as you have been tracking your expenses you have been able to find ways to save yourself hundreds if not thousands of dollars each year. I highly encourage you to take this savings and start aggressively paying down any debt that you may have. There are two main, but differing, methods put forth for paying down debt and they are the debt snowball and the debt avalanche. The debt snowball method encourages throwing all your money at your smallest debt first, while making the minimum payment on your other debts, and then moving onto your next smallest debt amount and repeating until all debt is gone. The debt avalanche method encourages throwing all your money at the debt with the highest interest rate, while making the minimum payments on your other debt, and then moving onto the next highest interest rate and repeating until all debt is gone.
While the debt avalanche method is the mathematically superior method, as you will end up paying less money overall by removing the highest interest loans first, this is one area where it is important to know yourself before choosing a method. The benefit of the debt snowball is the psychological wins, being able to celebrate and check off loans and see it is possible to eliminate them. No matter which method you choose you will be one step closer to freedom!
