We all have a relationship with debt in some way, shape, or manner. Also, like other relationships in our lives, it can be complicated. So let’s examine this creature and look at some basics for “safe handling”.
First, why would I say we all a have relationship with debt? Well, the neighborhood school was financed with bonds, a form of debt, which determines in part how much taxes you pay. In the past decade there have been two major economic upheavals due in large part to debt; the 2000 tech bust which had been fueled by reckless financing of internet and technology start-ups, and now the housing & real estate bust following a unsustainable bubble also fueled by debt. These debt-fueled booms and busts in turn influence inflation, interest rates, unemployment, investment performance of your retirement accounts, property values, taxes, and more. Clearly even if you are debt free and use only cash for purchases, the use of debt by others pervades your life.
With so much apparently beyond our control, what should we do? First it’s useful to visualize your family finances as a business entity regardless of what you actually do for a living. The goal of Your Family Inc is to increase it’s value (net worth) and profitability (income). What will or won’t contribute to those goals? I’m going to focus here on cars and houses because these are high-value items that can have a big influence on our finances.
First, your automobiles: Unless you use your vehicles in a genuine money-making endeavor they are a negative force on your balance sheet. They lose value steadily and they cost you to insure and maintain. Having a loan on the car compounds this because you are paying interest on an object that is losing value, which increases the total cost of ownership significantly. Answer; pay cash for your ride. What?!! You say. “I couldn’t possible drive the car I want if I had to pay cash”. Exactly. Drive what you can pay cash for, not what you “want”. There are multitudes of sources on how buy a good used car so don’t let that be a deterrent to action.
Now take what you were paying as a car payment and save up to buy a rental property, or put in your IRA, or increase your 401(k) contribution. Make a choice that has the potential for appreciation in value rather than guaranteed depreciation in value and your net worth will benefit.
Owning your home: A house is a place to live, not an investment per se. Shocking I know. Houses can be good investments, but that should not be the expectation. If you take the cost of taxes, repairs/maintenance, upgrades, interest costs on your loan, insurance and all other incidental costs of ownership the “investment value” of your home declines dramatically.
One of the big advantages of home ownership is the effect of “fixing” the costs. Rents rise with inflation whereas the cost of your loan is fixed on a 30 or 15 year fixed loan, and as your income rises (hopefully) and inflation takes it course your cost of ownership falls in relation to other rising expenses. So don’t go and ruin it with an adjustable rate loan, or refinancing in a way that increases the balance significantly.
The debt lesson for today; ditch the car loan to help increase Your Family Inc’s future net worth and “fix” the house loan to improve its “profitability”.