We all have a relationship with debt in some way, shape, or manner. Like other relationships in our lives, it can be complicated. Let’s examine this creature and look at some of the basics for “safe handling” of debt.
First, why would I say that 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 tax you pay. In the past decade and a half there have been two major economic upheavals due in large part to debt: the 2000 tech bust which was fueled by reckless financing of internet and technology start-ups, and now the housing & real estate bust following an 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. With all of that said, 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 can 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 its value (net worth) and profitability (income). What will contribute to these goals? What will hinder them? I’m going to focus here on cars and houses because these are high-value items that have a significant influence on a family’s finances.
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; this increases the total cost of ownership significantly. Answer: pay cash for your ride. “What?!” you say, “I couldn’t possibly drive the car I wanted if I had to pay cash.” Exactly. Drive what you can pay cash for — not what you’ve set your heart on. There are a multitude of resources which can help you go about buying a good used car.
Now, take what you were paying on your car every month and save up to buy a rental property, or put it 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. While houses can be good investments, that should not be your 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 its 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 your profitability.
