Increase Your Wealth and Happiness by Using Debt Wisely

by Mark on February 4, 2010

Here in the United States, we get bombarded with news stories about consumer debt, mortgage debt, business debt, and government debt. Unfortunately, these stories are always negative. We hear about record numbers of bankruptcies, foreclosures, destroyed lives, divorces, and on and on. In a country as wealthy as the United States, it is such an incredible waste for so many people to suffer from stress caused by excessive levels of debt. If you are conscious and deliberate in your use of debt, you can avoid these problems.

“Debt, n. An ingenious substitute for the chain and whip of the slavedriver.”
– Ambrose Bierce (The Devil’s Dictionary) –

Here are strategies you can use to reduce your stress and increase your wealth and happiness:

1) Avoid Consumer Debt Completely. Consumer debt is debt that is used to purchase things that depreciate in value, such as cars, boats, jet skis, TV’s, vacations, and on and on. Consumer debt is the most destructive type of debt and is aptly named because it consumes your wealth. One particularly harmful impact that debt has on us is that we often are willing to spend far more when we borrow than when we pay cash because focusing on the monthly payment makes the cost seem so much lower. How many people would buy a $40,000 car if they had to pay for it with cash? Not many. It suddenly becomes much clearer just how expensive the car is. It takes a lot of work for most of us to earn $40,000. How long would it take you to actually save $40,000? It would probably take you a fair amount of time, which is why so many of us take out a loan to buy cars. Because of interest, we then end up paying far more than the original price that we couldn’t afford in the first place. Get off the consumer debt treadmill. Just say no to consumer debt and start saving cash for your purchases.

“Some debts are fun when you are acquiring them, but none are fun when you set about retiring them.”
– Ogden Nash –

2) Beware the Zero-Interest and Tax Savings Traps. Everywhere you look, you see zero-interest or low-interest loans or you hear about how much income tax you can save because of the interest deduction on a mortgage or home-equity loan. While the interest and tax savings might be nice, we too often use these as excuses to help rationalize making a purchase we really can’t afford. Businesses offer zero-interest or low-interest loans and emphasize tax savings because they know that it will encourage us to spend more. Be careful not to let the prospect of saving interest or taxes influence your purchase decision too strongly.

3) Don’t consolidate your debt. After people accumulate a lot of debt, there is a strong temptation to consolidate the debt in order to reduce the monthly payments. The intention, of course, is that they will get be able to get off the debt treadmill once they have a little “breathing room.” There are a number of companies – some of which are very questionable – that are eager to help us do it. Many of them will use the low-interest and tax savings traps in order to encourage us. For example, a very common strategy is to pay off consumer debt with a home equity-loan, where the interest may be tax deductible. The problem is that most people who consolidate debt end up using the credit that was freed up by taking the consolidation loan, so now they have the consolidation loan and the original debt is back. Don’t consolidate. It will just make it easier to increase your debt even more. Just bite the bullet, cut your spending, and pay down the debt.

4) Don’t take out interest-only loans. Interest-only loans, which are loans that don’t require any payment of principal for a certain period of time, are another attempt to get us to borrow more than we can afford. Usually we tell ourselves that we will be able to “flip” the property before we have to pay principal or that due to a raise or a new job that we are expecting we will be in a position to afford higher payments once principal payments are due. It’s a dangerous game that I don’t recommend. If you can’t afford loan payments that include principal, don’t do it.

5) Don’t buy more house than you can afford. The tendency is to want to buy your dream house now, and it is easy to come up with all sorts of rationalizations to justify buying a house that is too expensive. “It’s a great investment.” “The mortgage interest and real estate taxes are tax deductible.” “You only live once.” “Interest rates are low right now.” Creative minds can come up with all sorts of excuses to buy. My recommendation is to pay a minimum of a 20% down payment (and preferably more), and make sure that your monthly payments are low enough to allow you to comfortably save for the future.

“This would be a much better world if more married couples were as deeply in love as they are in debt.”
– Earl Wilson –

6) Be conservative when taking out business loans. The best type of business loan is a loan to buy or expand an existing business with a stable cash flow that is sufficient to comfortably service the loan. If you want to take on riskier ventures, your best bet is to wait until you have some kind of stable cash flow first. It is extraordinarily difficult to predict the results of a new venture, and it is extremely common to overestimate the results that will be achieved.

7) Don’t use margin debt. Margin debt, which is debt that is secured by stocks, options, or similar assets, can be a particularly dangerous form of debt. If the assets in your account decline in value, the broker can sell the assets to pay off the margin loan. Not only would you be buying high and selling low, you would also be losing more money than you invested in the first place. Your potential returns will be lower if you don’t use margin debt, but you will have less stress and less risk. Do yourself a favor, and avoid the “quick buck” mentality. Paradoxically, you will most likely get wealthy quicker by being patient anyway.

“Debt is a prolific mother of folly and of crime.”
– Benjamin Disraeli –

The Common Denominator

The common denominator with all these strategies is that they encourage us to keep debt at conservative levels relative to our income and assets and to prevent us from rationalizing our decisions. The ability to rationalize our behavior is what separates us from animals! Be honest with yourself. Monitor your thought processes. Notice the tricks that your brain plays on you in order to convince you to do what you want to do instead of what you should do. If you always pay in cash or make very large down payments, the relative importance of the purchases will be much clearer to you. It will be much easier to decide if the purchase is really worth it. The true cost will be much more real to you.

Your brain will come up with all sorts of reasons not to be patient and not to save your money instead. It is when you are least motivated to be patient that you have to be most careful. Don’t fall for it. Succumbing to the desire to spend more now rarely brings us long-term happiness. For most people, the peace of mind from having a cash cushion and little or no debt brings us far more happiness than immediate material gratification, which is often short-lived and disappointing. I certainly am not trying to convince you that debt is bad. I am just trying to encourage you to be brutally honest with yourself before making decisions. You will be glad you did in the long run.

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