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The topic of personal debt certainly takes a butt-kicking on personal finance blogs. It seems that most of the mainstream PF bloggers follow the Dave Ramsay line of thinking on debt – that it’s awful and should be avoided at all costs.
Though I can not stand listening to the Dave Ramsay show, I think his financial principles are sound. I prefer to have no debt whatsoever.
My wife and I had more than 40k in vehicle and credit card debt when we were married and I’m proud that we were able to pay it all off. I believe that if you can completely eliminate debt from your life, you’ll be better off.
Debt can drag you down and prevent you from experiencing some of the best that life has to offer. It can ruin relationships and let’s not forget, interest rates on credit cards, consumer loans and car loans make borrowing money incredibly expensive.
That said, there’s something about debt that you need to know.
Not all debt is equal.
Yah that’s right, I said it.
In my perfect world, we’d all be happily debt-free forever. Over the years though, my view of debt has softened.
These days, I believe that debt can be a useful tool and there are circumstances where it makes sense to use debt to achieve a short-term goal.
A friend of mine is very financially savvy. Him and his wife are in their late 40s and own their home outright (a nice home in a very expensive market). He’s the kind of guy I go to for financial advice.
A couple of years ago he was shopping for a new car for his wife. He had the cash on-hand to buy the car, but he decided to finance it at 0% instead and invest the money. For him, this decision made sense. He had the money but didn’t want to tie it up in a car when he could grow it somewhere else.
Because my friend has worked hard to put himself in a great position financially, debt was an option for him. It was actually a way for him to save some money, and because he had the cash on-hand to pay it off, there was very little risk.
Before you take on debt, I encourage you to ask yourself the following questions.
Is this something that you need, or something that you want?
No judgement here, the point is that you need to be honest with yourself about whether you’re taking on debt because it’s absolutely necessary, or if you’re fulfilling a desire that you could do without.
Do you know how much this debt is going to cost you, over how long?
You’ll pay interest on most debt, but do you know how much? If you’re financing a new item from a store or dealer, make sure they tell you how much the financing is going to cost you over the term of the loan. That’s the total cost of your purchase.
It is also wise to negotiate a deal off of this number, rather than the monthly payment.
How long could you make your payment for if you lost your main source of income?
If you’re in a position where you could not make your payment for 3-6 months if you lost your job, you might want to look at other options.
Let’s look at a couple of scenarios:
Guy 1 drives a beater and wants to upgrade his vehicle. He goes down to the car dealer and finances a brand new pickup truck for 50k over 8 years with no money down. The dealer offers him 2k in trade for his junk car, and he feels like that’s a great deal. Two days later the truck has depreciated by about a quarter and is now worth about 37.5k.
He now owes 48k (plus interest) on a truck that is worth 37.5k. He is ‘upside down’ on the vehicle meaning that he owes more on the truck than it is worth.
Guy 2 drives a beater and wants to upgrade his vehicle, and also has no cash on-hand. He decides to take on some extra work and save for a down payment on a good truck. After a few months, he’s been able to save up 5k. Guy 2 is able to secure financing through his bank and finds a great deal on a nice five-year-old pickup truck for 15k. He owes just 10k (plus interest) on a truck that is worth 15k.
I hope that we can all agree that Guy 2 is in a far better financial position with his vehicle than Guy 1. Guy 2’s truck is worth 5k more than he owes on it. This means that if he comes into hard times, selling the truck is an option for him and he won’t be left with debt.
(I understand that the above example is incredibly simplistic and doesn’t account for taxes, insurance, fees or all of the extras that the dealer might talk you into.)
Of course neither of these is a perfect scenario. In a perfect world, both Guy 1 and Guy 2 would save for as long as it takes to buy the truck and they’d be happily driving debt-free.
But we don’t live in a perfect world. Sometimes shit happens. Sometimes your engine blows up with two kids in the back seat and tomorrow’s a work day.
There are times in life when we need to make decisions quickly. Sometimes we’re in a position where the most logical choice seems to be to take on a bit of short-term debt – and that’s okay. The key is to have a plan for paying off the debt.
Seek qualified advice
If you’re considering taking on debt for any reason, I would encourage you to talk to a couple of people about it first.
It’s important that you only take financial advice from people that meet these two criteria.
First, it should be somebody that you trust.
Second, they should be somebody who uses money wisely and isn’t drowning in debt.
I’m sure your uncle Steve means well but if he owes 30k on a hot tub and a timeshare, he’s probably not somebody you want to take financial advice from.
My short-term personal finance goal is to get to a place where my emergency fund can cover any unexpected expense, including a vehicle if necessary. It’s wise to have a healthy emergency fund and I recommend that you start one yesterday.
In the meantime, no matter what the personal finance blogging masses are saying, you are the only one who knows your situation. You are the one who has that tiny, honest voice inside your head telling you if this is truly a good or bad idea.
Question for you:
Have you had to make a difficult financial decision? What was it?