August 2, 2018

Debt Is the Enemy (Part 1)

Ever build one of those mortgage spreadsheets? Take your interest rate, the term of the mortgage, your payment, and plug it all into a spreadsheet to see how it amortizes over time?

It’s a pretty good exercise. Here is the key step—open that spreadsheet and add up the interest you will pay over time, assuming you don’t make any prepayments.

The answer will probably blow your head off.

For example, on a $250,000 30-year 4% fixed rate mortgage, you will pay about $430,000 in interest over the course of those 30 years.

Every butthead reading this is like, “But you get to deduct that from your taxes!”

I have never understood that philosophy. You would rather pay more money than less money so you can get some of it back?

True, mortgage interest is tax-advantaged (for the time being), but most of the money you pay in interest is unproductive. It doesn’t do anything. That is the price you pay for the ability to spend money you don’t have. And it is expensive.

If you pay your mortgage dutifully, you are a good customer of the bank. You are making a banker rich. Who wants to make a banker rich? Or worse, some giant faceless corporation?

Don’t be a good customer of the bank, be a bad customer.

Prepaying a mortgage (especially if interest rates fall) puts the bank into a pickle—it has to decide whether to reinvest the money at a lower rate of interest. This is known as reinvestment risk.

Credit card interest, also unproductive. Car loan interest, unproductive. Student loan interest, unproductive. Who has ever been happy about the hundreds of thousands of dollars people pay in interest? Think of all the things you could have bought with that money.

Nobody thinks about this.

It’s just a fact of life that you have to have a car loan, a mortgage, credit card debt, and other forms of debt. It’s the American way, man, get with the gosh darn program. (I’m being sarcastic. You don’t have to have any of this debt.)

I’m with Dave Ramsey on this—you don’t have to have a car loan. I’ve had two car loans in my life, both through USAA.

The last one was 4% and I paid $8,000 in interest over five years. I wasn’t happy about paying $8,000 in interest. I thought there were other things I could have done with that money. I took the loan because it was offered to me—I didn’t put a lot of thought into it. And then I had 600 bucks going out the door every month.

Debt is bad. The interest you pay is unproductive. It is flushing money down the toilet. Flusssssshhhhhhhhh.

The Worst

Credit card debt is the worst. Of all the years I have had credit cards, only once did I carry a balance for a month. I was just curious to see what would happen. I got charged $50 in interest is what happened. Welp, that was fun.

There are people who carry tens of thousands of dollars (or more) in credit card debt and pay the monthly minimum, incurring hundreds of dollars of interest charges every month. Talk about being a good customer!

I do not understand why someone would limp along like a cancer patient under the crushing burden of all this debt, and not take any action to get out from under it. Bankruptcy is obviously an option, but a better option is to implement some austerity, start saving money and chip away at those credit card balances. You can get it to zero over time if you work at it.

Credit card debt should not be used at all. Of course, credit cards also are a medium of exchange. You can pay for pretty much anything with a credit card nowadays.

Mr. Ramsey advocates going without credit cards altogether. I disagree. Being part of civilized society means you have to have a few credit cards to pay for stuff. Ramsey infantilizes you and says that you cannot be trusted with it. I say that you can—it just takes more discipline. Pay that sucker off every month.

Some people like to use credit cards for “emergency expenses,” but I don’t think that is such a hot idea. I think a hotter idea is to carry lots of cash (see last week’s issue) which can help you absorb any unforeseen expenditures. If you get hit by a cement mixer and you put your medical bills on a credit card, that will accumulate interest. And I suspect that slug of debt will become a permanent feature of your finances.

As for the points and the rewards, eh. They’re not that big of a deal. Most people don’t spend enough to get anything good, and those points/miles expire pretty quickly. People can be greedy about accumulating points, but very few get around to using them1.

If you have a balance, pay it off. If you have multiple balances, pay them all off. You should pay them off before you pay off your other debt because you are getting violated by the interest rate.

You have to take action. Leaving those bills unopened on the counter doesn’t mean this is all going to go away.

Brief Interlude

I should mention that Mauldin Economics’ VIP offer—get seven premium services for a minimum discount of 66%—opened up to new members this week.

Street Freak and ETF 20/20 are included in the deal. So if you want to save thousands of dollars and get full access to some of the best newsletters around, you should check it out.

By the time next week’s issue of The 10th Man is published, the VIP offer will be closed, so consider this my public service announcement. VIP is a cost-efficient way to get everything published by Mauldin—it’s a great deal.

The money you pay for it is not what I would characterize as unproductive.

One Last Thing

The number one question I get as a financial writer—

--I mean the number one question—

“Why should I pay down my mortgage/car loan/credit cards? I can earn more than that in the stock market.”

Uh, no, you can’t.

Even if the after-tax interest rate for your mortgage is below 3%, there is no guarantee that you will be able to beat it.

All you will have done is swollen your balance sheet, with lots of assets and lots of liabilities. Shrink the balance sheet. Make it smaller.

It’s about safety. Once you own your house/car/life free and clear, there is no better feeling in the world.

The stock market may not behave. Then you’ll have debt and losses. Take care of the debt first—after that, start looking at making money in the stock market.

Freedom

Think of the thousands of dollars you have going out the door in debt service payments:

Some of this debt is “better” than others, but it’s all bad. Imagine you got rid of it all, and you had your income—all of it—turn into pure, free cash flow.

Is that even possible?

Next week, I will tell you that it is.
__________
1 I get a free trip to Vegas from credit card points every year (flight and hotel), but that’s not something you should strive for.

Jared Dillian
Editor, The 10th Man

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