The Borrower is Slave to the Lender: A Debt Manifesto

You’re in for a treat. Some pontificating on the use of borrowed money. The good, bad, and mostly ugly….

INTRODUCTION

This whole civilization thing has been a huge mistake and we are all better off hunting/gathering.

Our life script is broken…

Act 1 – Get good grades, get into college and take student loans to do it.
Act 2 – Get a job with steady income, rent a place to live, and buy a car using a loan.
Act 3 – Save up for a minimal down payment, and buy a house with a 30-year mortgage
Act 4 – Live happily ever after

Since we do live in this complex world, we should probably make the best of it and learn about how to properly operate in it. Money is a key variable and an effective tool for navigating this crazy place. But yet we are so terrible at it!! And the script above is NOT helping us.

In 2016, The FINRA Foundation revealed that 63% of participants scored 3 out of 5 or lower on a financial literacy test covering interest rates, inflation, bond prices, mortgage interest and investment risk. This lack of financial literacy appeared to be reflected in some of the other findings from the study too; such as 18% of respondents spend more than they earn, 21% have overdue medical bills, 26% have used non-bank borrowing (such as high-interest payday loans or pawn shop loans), and 32% only pay the minimum due on their credit cards. And even more startling less than half (46%) have a financial emergency fund set aside for financial/life crisis.

Here’s the financial literacy test if you want to see how you’d fair.

It’ll take 3 minutes. There are only 5 questions. Don’t worry no one will know your score but you.

Chances are that if you’re reading this, you have some sort of financial blind spot. That’s not an attack, just statistics. America has a consumer debt problem. And it’s not all our fault. It’s not like our schools or our parents taught us this stuff.

I don’t consider myself a financial guru. I’m no Dave Ramsey or Ric Edelman. However, I’ve developed a few principles for when it comes to borrowing money. I reserve the right to adjust or change my manifesto…because, well…it’s mine and I can do what I want. Lastly, I am not anti-debt just like I am not anti-alcohol. However, I think we should use both responsibly.

DISCLAIMER

Many people are NOT going to agree with what I’ve put in the Manifesto. Here are going to be some of the common responses:

Using debt for higher education is ‘ok’.
I’m doing it for the perks (points, extra savings, etc.)
No one buys a car with cash.
No one buys a house with cash.
The interest rate is so low, mathematically it is nearly free money!

Some might even get angry or want to argue. Here’s why:

They already have used debt to their perceived benefit.
Some might feel I am even talking down to them.
They’re analytical and everything is a math response.

Money has deep psychological roots. I can’t address everyone’s situation. What I will say is that I believe most people would be better off if they just did the following…

THE MANIFESTO

We should NOT use debt until we have done the following…

1. We should have to take a class or read a few books.

We do not allow people behind the wheel of a 2 or 3,000lb car without having a valid driver’s license. But we allow people to take out student loans, get credit cards, and buy cars with a simple application and no indication that they actually know what they are doing. We expect people to know and understand how money and debt work, but honestly, it’s not an easy topic to understand unless you have been taught or are self-taught.

What to read:

• JL Collins Stock Series Blog
• Or any of 3AT’s Personal Finance Book Recommendations

You can also take a personal finance course at a local community college in your area. Do not be ashamed that you feel under-educated in this arena, as you can tell by the statistics provided above, many people are in the same boat as you. Just don’t stay in denial any longer.

2. We should have to have a budget.

We go shopping but we don’t know what we spend. Do you know how much your household spends on food each month? Do you have more money coming in than going out each month? Are you leaking dollars like a sieve? It has never been easier via technology to create and track a budget. There are so many applications, many of which connect right to your bank accounts.

Some examples of apps to help you get started:

• Mint
• YNAB (You Need A Budget)
• EveryDollar
• GoodBudget

Plug the money leaks so you can concentrate on #3 and #4 of this manifesto. Make sure you have more coming in than what is going out.

3. We should have a healthy emergency fund.

If your life depended on it, could you write a check tomorrow for two months’ worth of your household expenses? No? How about just $1,000? Could you write a small 4-figure check to make a problem go away? Across all income levels, less than half of Americans have a solid emergency fund.

There is no “right level of emergency savings” that someone needs set aside. Everyone’s risk tolerance and monthly expenditures are different, but many experts recommend (at minimum) to keep 3 months worth of household expenses safely kept away in a savings account.

When the car breaks…when you lose your job…when surprise medical bills pop up– You’ll find yourself a lot less stressed out knowing you have that nice comfy emergency fund set aside for just that purpose.

4. We should have a positive net worth and it should be growing.

Net worth, much more than salary or credit score, is a strong barometer of financial health. If you need a definition of net worth or other financial terms you can check out my piece “Your Network is your Net Worth“.

In the United States, it is typically acceptable to have a negative net worth as long as you have a significant income to get out of debt over time. Which is strange, isn’t it? There is a lot more risk than we realize when we take on student loans, a car payment, and/or a mortgage and trust that the income is always going to be there to cover the payments.

Income is like a shovel. We want to be filling small holes (debt) rather than justifying digging bigger ones just because we have a formidable shovel.

If you have significant assets (home equity, savings, retirement funds) compared to your liabilities (consumer debt, student loans, etc.) and have demonstrated your mastery of the earlier steps, then utilizing credit is much more palatable.

CONCLUSION

We should not use debt to purchase depreciating assets unless it’s paid off monthly. If we have mastered and made it through the four principles then absolutely feel free to get a credit card to collect cash back, points, or travel miles. Just make sure you pay it off each month.

The rest of loan making and debt creation centers on planning and risk.

It does not make mathematical sense to use any interest-carrying debt to purchase depreciating assets (boats, cars, consumer products, etc.). Cars are typically the “socially acceptable” item to use loans on. But perhaps we should change our paradigm. Instead of utilizing loans, why not financially plan for something you know you are going to have to buy periodically throughout your life?

I’ll only comment briefly on student loans. I understand the need for their existence, but at the same time, there is little education on how to minimize their use or how to quantify the return on investment. And this has led to an epidemic issue in America. Graduates are drowning in their debt. Generally, if we choose a large public institution in our state, choose a major that is in market demand, and work to receive some income then perhaps we have minimized the use of debt as much as we can.

Which leads me to the scenario of proper debt usage. Assets that we generally consider appreciating (purchasing real estate or a business) still carry a significant amount of risk when using debt to acquire them. But a healthy down payment can curb some of that risk, and if we can pay down the principal of the loan quickly and ahead of schedule, then we have placed ourselves in a very advantageous position financially.

The script needs to change.

So what do you think? What constitutes responsible debt use?

And if you have made mistakes with debt, just remember….

A failure is a man who has blundered but is not able to cash in on the experience. – Elbert Hubbard, American writer, publisher, artist, and philosopher.

Hope to hear from you soon!

PS