I’ve written about debt and debt pay down strategies before. I literally, at one point, wrote a Debt Manifesto. But I don’t think I’ve written a piece specifically on the strategic use of debt and my thoughts on it.
I think for a large majority of today’s society the ALL DEBT IS BAD philosophy is a one size fits all approach that takes risk completely out of the picture and guarantees success for many people, assuming their investment strategy is sound. This a strong defensive stance but is not necessarily being the best steward of your finances in all cases.
To explain further I put some maxims together that summarizes my personal philosophy on debt:
~ If the debt cannot make you money, avoid it ALWAYS.
~ If buying something will not make you money, avoid buying it unless you can buy it OUTRIGHT.
This pretty much outlaws any consumer debt. Simple, right? It’s easy to say and read but often hard to practice in today’s society. No $10,000 vacations that you pay off over 5 years. No credit cards that you carry a balance on beyond 30 days. No phone, TV, furniture, computer, or vehicle purchases that have low payments per month but that you pay for over the entire useful life of the item.
But that does not mean using debt is ALL BAD. Conversely to the two maxims above:
~ If the debt will make you more money, do it SOMETIMES.
~ If buying something will make you more money, finance it SOMETIMES.
Here’s where things get murky and the scenarios are not always cut and dry. The “sometimes” centers around risk; mortgages and student loans are the two perfect examples.
At the time of this piece, prevailing interest rates are below 4% on mortgages and most people are receiving a mortgage interest write off on their taxes. This makes borrowing a large sum of money for a house one of the best uses of debt available. This does not even take into account the benefits of borrowing money at today’s dollars, e.g. inflation.
Obviously risk plays a role here. You don’t want to limit your future flexibility by overbuying or putting too little down. You always want to put between 15-20% down. At least that way if something happens in life (job change, divorce, etc.), you’ll be in a better position to sell without having to bring cash to the table. Additionally, you want to settle on a monthly payment that is low and manageable allowing you the flexibility to save and invest elsewhere. Often this means going with a 30-year mortgage and being conservative.
Generally speaking, I’m also a big proponent of using debt to buy an investment property. I will likely write a whole piece on this at some point but putting 20-30% down with a 30-year fixed rate on an underpriced property that cash flows using rental income is a use of debt that I personally approve and a tactic I use as part of my own investment strategy.
In my mind, the decision to take student loans should be one that focuses on: 1. How do I minimize them?, and 2. Will the degree I seek have a significant return on investment in the prevailing job market?
Minimizing the loans involves working through college, choosing an institution based on lower costs (mix of community college and/or large public university), and obtaining scholarships.
Choosing a field of study can be difficult, but the return on investment is so important here. Very few people know at the outset what they really want to do, and the vast majority of people change their majors while in school. But if you can minimize the use of loans, then at least you can switch from being pre-med to history without feeling like you are strapping yourself to six-figure loan debt and a smaller future income. On the other hand, if you were clearly built to be a doctor, lawyer, and/or engineer perhaps taking on a bit more debt is acceptable.
If you already have student loan debt, and it’s carrying a 5% or greater interest rate, I’d advise you to pay it down as quickly as possible.
- Formulate your own personal philosophy on debt and write it down. When is debt acceptable to you? Certainly, be honest and make sure it aligns with your personal ethos and investment strategies.
- Live that philosophy. Make the changes in your life necessary to make sure you are being true to your values when it comes to debt.
- Ask questions. Share your thoughts with someone who is 10-20 years ahead of you but who appears to be living by a similar philosophy. Also, if you want someone to bounce ideas of off, feel free to reach out.**