Debt is the boogie man of personal finance.
It doesn’t get much love from most bloggers, probably because most people do stupid things with debt instead of smart things.
High-interest credit card debt is foolish. Payday loans are ludicrous.
But a mortgage is a solid financial tool if you’re prepared to buy a home and don’t overspend. Debt investments provide reliable income and predictable returns.
But as I’ve continued to lower our financial risk by reducing debt, I’ve started to love debt’s positive attributes.
Here are six things I love about debt.
1. The Debt of Others Makes Me Wealthier
There’s an overabundance of debt usage by individuals in America, whether it be student loans, credit card debt, sub-prime mortgages, excessive business debt, or auto loans.
While so many people are saddling themselves with more debt while economic times are good, we only have a modest mortgage that decreases every month.
Knowing that other people are going deeper into debt, servicing that debt with their earned income instead of building wealth, makes me feel wealthier.
Of course, using debt wisely can lead to greater wealth in the long-term — for example, a timely small business loan, or using a student loan to attain a high-value degree.
But let’s face it, the people that borrow unwisely are less financially secure than the rest of us.
High-interest credit card debt costs anywhere from 12% to 30%. That’s wealth-crippling!
The average car payment for a new car is $550. Car payments are a normal part of life for many, but they suffocate your monthly budget.
I don’t wish excessive debt on anyone. But knowing that so many people are overburdened and more vulnerable when the next recession hits, oddly gives me the warm fuzzies.
2. Debt is a Relatively Safe and Plentiful Investment
In personal finance, debt is an ugly, dream-crushing beast.
But on the other side, for every debt, someone earns money. Credit card companies are hugely profitable, despite returning cash and travel rewards to customers. We can own the stocks of credit card issuers and transaction processers and share their profits.
I own Visa (V) and Bank of America (BAC) stocks.
Governments and corporations use debt as a financial tool to spend on things today to be paid for tomorrow. Hopefully, the borrowing is done wisely. Borrowing by these entities creates a giant marketplace (trillions of dollars) utilized by global investors to earn fixed returns to build wealth.
Risk ratings determine returns, so there’s a wide range of options for all appetites.
I own this debt through mutual funds.
I invest in real estate debt through a crowdfunding platform called PeerStreet (review). My returns are in the range of 7%-9% before taxes. PeerStreet provides crowdfunded loans to real estate developers. So I’m lending money to someone who will use it to earn a profit. It’s a win-win.
Real estate debt is generally better than consumer debt, which is why I’ve ceased new investments on the LendingClub platform.
Debt can certainly be a detriment to your financial well-being if you let it. But it’s a pretty awesome financial instrument if you use it to become wealthier.
3. Debt Repayment is a Measurable Risk-Free Return
When I bought my 2002 Toyota Echo (and turned down a job offer to work at the dealership), I wasn’t thrilled to have a $220.61 car payment at 4.59% interest.
But I was pretty damn excited to make a new spreadsheet to pay it off. I paid the 66-month loan off in 30 months and drove it for another six years.
I started by paying the minimum, but slowly increased the payments until it was within payoff reach. Here’s a screenshot of the spreadsheet and all the extra payments.
Here’s that car repayment spreadsheet if you want a copy.
When borrowing for a car or house (or any debt), it’s easy to estimate how quickly you can pay it off once you have a spreadsheet for it. I used to love doing this with our minivan and second mortgage on the old condo.
But I love not having debts more than spreadsheets.
Every penny I put toward the debt was a risk-free return on my payment. The second mortgage interest rate was above 8%. It’s hard to earn that kind of investment performance anywhere else, especially without the risk.
Paying off debt is a risk-free return equal to the interest rate. This is why paying off high-interest consumer debt is a no-brainer.
You don’t have to look at past performance and hope to achieve future results (like stocks). The return is guaranteed. The only caveat is if you’re getting a tax benefit for holding some real estate debt (e.g., mortgage, HELOC).
4. Debt is a Titan Killer
Debt-free companies don’t go bankrupt. Debt-free individuals don’t go bankrupt.
Companies with lots of debt probably won’t go bankrupt. But they can.
Look no further than Lehman Brothers in 2008. The company was considered a stalwart financial institution, too smart for its own complicated web of sub-prime mortgage derivatives on its balance sheet.
There’s a whole story behind why Lehman Brothers collapsed. But I’ll give you the Cliff’s Notes – too much debt.
Enron scandal? It used “special purpose entities” to hide its debts.
Worldcom? Crushed by its $41 billion debt load (and terrible accounting).
Debt has a funny way of exposing charlatan companies when the economy sours. Unfortunately, the executives aren’t always held accountable.
Big corporate bankruptcies are some of the most fascinating stories in business history. I’ve enjoyed watching this happen because it ultimately strengthens the competitive positions of legitimate, well-run companies. The key is to own strong companies and avoid the vulnerable.
Performing due diligence to identify the best companies in an industry is a pillar of long-term investing.
Only when the tide goes out do you discover who’s been swimming naked. – Warren Buffett
5. Debt Opens Doors
Our family has a mortgage. The mortgage makes it possible for us to own a more suitable home than we could afford in our area if we had to pay all cash (of course, nearly everybody has a mortgage, inflating prices).
Instead of paying all-cash for the home, we use the mortgage to enable us to invest in our future. Since stocks have a higher long-term rate of return than our mortgage interest rate (currently 3.375%), we become wealthier over time.
Mortgage debt is unique in this regard because real estate appreciates over the long-term.
Debt empowers us to buy many things we can’t otherwise afford. We could use debt to buy a luxury car or a new kitchen, but our family avoids those temptations. Cars lose value. A modern kitchen might not increase the value of our home by as much as it cost.
Spontaneous purchases at the mall become nearly worthless the moment we buy them. Even though debt can give us what we want sooner, it’s usually not smart to do it.
Debt is a perpetual test of self-control.
6. Debt Earns Benefits
I spend everything I can on one credit card. Each transaction is listed chronologically on my online account and monthly statement. I can review the account to know exactly where I spent my money.
Cash doesn’t do that.
With a credit card in my wallet, I always have the money I need.
Credit card spending is debt. Every dollar I borrow to make a purchase costs me nothing because I pay off the balance each month and never miss a payment. I haven’t carried a credit card balance since college (and that only lasted a month or two).
It’s pretty great when you think about it. Credit cards let you borrow money for 30-45 days or so, interest-free, letting you do other important things with your cash on hand.
And it gets better. Credit card companies reward your spending with bonuses such as travel rewards and cash-back. They offer free rental car insurance, protect you from fraud, and offer discounts at retail partners.
You can get similar rewards with debit card spending, but the bonuses earned from opening a credit card account and spending the minimum are some of the best deals in personal finance and travel.
Credit card reward miles and cash-back are not possible without going into debt. If you pay attention when the bills come due and keep enough money around the pay the bills, you earn the rewards.
What do you think? Debt – love it or hate it?
Photo via DepositPhotos used under license
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