Debt From Another Angle

Today’s guest article gives a different viewpoint about debt. I have my own voice when it comes to debt, and it’s sort of nice to hear the viewpoints of other people. Adam from over at Rotten Bananas was kind enough to share some of his thoughts about debt.

This is in no way an attempt to overshadow the problems associated with debt. I couldn’t begin to understand the weight felt by someone with $38,000 in debt. (By the way, $14,000 in one year is fantastic. Kudos to you, Tricia. I know a few people that would benefit immensely from that type of self-control and progress.) Frankly, I wouldn’t want to try to comprehend that, for reasons I will explain. My thought for this article was to offer people another perspective on debt.

To put it simply, I’m afraid of debt. Anticipating its inevitable arrival makes me very uncomfortable. We may be a small group, but there’s got to be others out there like me. But I wasn’t always like this. I’m a very recent college graduate with a decent sized school loan to pay off. When I was in school, I was still mostly being supported by my parents except for low-paying part-time jobs. For that reason, the commitment wasn’t so scary, but since then, things have changed.

Now that I’m graduated, moved out and “gainfully employed” (see accountable), I avoid debt at all costs. I’ve had a credit card for 2-3 years but have probably used it less than 10 times. I prefer to use my check card, which pulls the cash directly from my account, leaving nothing to chance. Naturally, this has left me with little in the way of credit.

I recently decided that it was time to replace my car. It was 10 years old, and I’d been driving it for 6. As we all know, as your vehicle’s value decreases, and the maintenance costs increase, moving on becomes more and more feasible. Now, I can’t say the idea wasn’t exciting, but it totally stressed me out. I hated the idea of having to dedicate two hundred and some odd dollars a month to a payment that would seemingly never end.

Now I’m facing one of the largest debts in my life. With only a few months left on my lease, it’s time to think about buying a house. Talk about scary. That’s a gigantic chunk of cash to dedicate each month. What if I can’t handle it? What if I lose my income? This are the ideas that I dwell on. Well, there’s some important positives to focus on when considering such a burden.

Buying a home is an investment.

Very few purchases in life come with the benefit of appreciation. Your car, your new couch, your refrigerator: all of these items will lower in value over time. Your house, on the other hand, will be worth more when you’re ready to move. In addition, you won’t be throwing away money on rent with absolutely no return.

Your income won’t decrease.

Obviously there are exceptions to this, as with every rule, but for the most part it’s true. Usually, your salary will only increase over time, never go down. Therefore, even if you’re a little strapped, things will never get worse.

The money saved can often be of better use elsewhere.

Let’s say for the sake of argument that you could afford to buy a new house outright. This is would be a huge temptation for me. There’d be no debt, no payments to worry about. Odds are, that wouldn’t be the best use of your money. More often than not, investing that cash would produce a higher return than the interest you’re gathering on your debt.

You’ll have collateral.

A house can be put up for a second mortgage, which is very attractive to a would-be, wannabe entrepreneur like myself. I know, I know. Just as I’m making my way out of the pool, I’m jumping back in the deep end, but that’s just how my mind works.

Some or all of these may seem completely obvious. For the most part, they are common knowledge. I’m not here to teach you so much as convince myself (and hopefully some others in the process) that debt is not the bug-eyed monster in the closet. In some cases it’s not ideal (depreciation, smaller paychecks, etc.), but it can often be the preferable choice to buying outright, and a necessary part of life.

These are the things I have to remind myself (and am reminded by others). In addition to easing my own stress a bit, I also wanted to provide another perspective on debt to the readers of Blogging Away Debt. Since most of the conversation on this site is about the evils of debt (and there are many), I thought I’d show that it’s not all perfume and roses on this side either!

Thanks Adam for the article!

Posted by Tricia on February 12, 2007 at 12:57 PM in General Debt | 5 Comments »
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Quang responded:
Posted: February 12th, 2007 at 4:11 pm
Great Tips! For someone who hasn’t even thought about buying home, it was a good overview, Thank!
rotten bananas » Blog Archive » Fear of Debt Article Featured on Blogging Away Debt responded:
Posted: February 12th, 2007 at 7:19 pm
[...] and used to seeing related material from her. Check it out! Posted in personal finance by fergs RSS 2.0 Leave YourComment [...]
Mike C responded:
Posted: February 13th, 2007 at 1:25 am
“Your house, on the other hand, will be worth more when youâ€™re ready to move.”

Sure, this is a fair enough assumption if you are planning to stay in the house for a long time. But if you’re a short-time owner in a real estate market with historical dramatic peaks and valleys (SoCal, Boston, San Fran, Miami), it’s worth it to track the recent local market price history to get a sense of whether you might face appreciation or depreciation in the short term.
Druce responded:
Posted: February 13th, 2007 at 3:08 am
I like what you added Mike C. When you figure in the added costs of insurance and property taxes, the average person will only see a positive return on their investment after seven years. I feel sorry for the condo flippers in Miami that are hemorrhaging money right now. Adam is right, there are good and bad liabilities. Credit card balances from a strip club are bad debt, while student loans, or a house are generally good debt. The difference is that student loans, or a house are a risk free investments. Where a positive return is usually assured. However, it is possible to have too much of a good thing. Typically mortgage underwriters use 28% of your income as a rule of thumb for the amount of real estate debt someone can handle, they do this for a reason. To figure out how much of a mortgage you can handle, take 1/3 of your gross income, or approximately half of your after tax income, subtract from that number how much you will have to pay in property tax and insurance. A note of caution, from my high school math teacher, make sure your terms are the same. If you get paid every two weeks, divide your pay check in half, and then subtract 1/26 of your estimated yearly property tax, and be conservative and use half of what your monthly insurance would be. Now grab a calculator, or a spreadsheet, and preform a future value function for that number and whatever interest rate would be reasonable. Now you have how much house you can afford!

As for the idea that real estate is an investment. It is an investment, especially when you consider the tax advantages, however there are many other asset classes. Historically, real estate has a 6% yearly return. Compared to the S&P 500 which has a historical rate of return of 11%. It seems to me that a more beneficial strategy would be to invest less then the 1/3 in real estate and put the remainder in a qualified retirement account.

One note of caution before I quit preaching. There is something that has been happening so frequently with the baby boomers that it has been coined, the middle class trap. Adam was right, incomes generally due increase, rather then decrease. As family’s incomes increase so do their spending. Unfortunately it has been common for family’s spending to increase even after they have hit a point where the rate of their income increase has leveled out. And they are forced into refinancing, or using a HELOC to pay off unsecured debt.
Adam responded:
Posted: February 13th, 2007 at 9:07 am
Good points guys. Thanks for commenting. You’re absolutely right about short term real estate flipping being a different business. That wasn’t my focus for the article. I was more concerned with long-term purchasing solely for living purposes.

Good information.