Feel the debt burden
We are an indebted nation thanks to our desire for more and our financial system’s ability to grant us more. When used appropriately, debt can help provide for a better life and make us wealthier. When used indiscriminately, however, debt can destroy our financial dreams.
Below is a list of the most indebted nations according to Trading Economics. Currently, America is at ~104% debt-to-GDP and historically ranged from a low of 31.7% to a high of 122%.
Whenever your country’s debt is greater than its GDP, it’s probably a good idea to encourage your politicians to exercise fiscal restraint lest they take your country to hell during the next financial crisis.
Notice how many of the most indebted countries such as Greece, Italy, and Portugal continue to struggle since the 2008-2009 financial crisis.
Source: Trading Economics, Debt-to-GDP ratio by Country
Let’s review the following types of consumer related debt and rank them from worst to best. We’ll also take a look at the latest interest rate by debt type.
Ranking Debt From Worst To Best
1) Credit card debt. The average APR on a credit card is ~15%. Some go as high as 29.99% if you’ve got terrible credit. This is such a ridiculously high interest rate which not even the annual returns of the great investor, Warren Buffet, can match.
If you carry a balance, credit card companies are ripping you off. They’re secretly hoping you spend more than you make or forget to pay off your balance each month. No Financial Samurai should ever have revolving credit card debt. Use a credit card for rewards points, insurance, a free 30 day loan, and concierge service, but that’s it.
I highly recommend reducing the time spent playing the 0% APR balance transfer game. Instead, focus on making more money instead. Don’t use the credit card as a crutch to support irresponsible spending habits.
Average credit card interest rate from 100 cards compiled by CreditCards.com
2) Automobile debt. Borrowing money to buy a depreciating asset is a really bad move. Some people justify their auto debt by saying it’s so low at 1.9% or whatever. But 1.9% is still too much when you’re losing money on a vehicle every month. If you are able to spend 1/5 – 1/10th of your gross income on a car, then you shouldn’t have to go into automobile debt. If you buy a car that’s 1/5 – 1/10th your gross income and can get a 0% loan so you can invest the difference, then fine. Otherwise, just say no to automobile debt.
3) Student loans. The older I get, the more I realize how vitally important education is for achieving financial freedom and happiness. When you have the knowledge and skills to make things happen, life gets so much easier. That said, there’s nothing you learn in college that you can’t learn for free on the internet. Therefore, skyrocketing college tuition seems more like a scam, especially since higher tuition doesn’t guarantee you a well-paying job upon graduation.
Unless your family is rich, choose a college that provides enough free grant money so that you’ll be able to pay everything back within four years of graduation. I’m highly biased towards state schools having attended The College of William & Mary for undergrad and UC Berkeley for business school. You can deduct up to $2,500 of student loan interest paid in any given year if your modified adjusted gross income is under $80,000 or $160,000 for married couples filing jointly.
Average student loan interest rate. All rates are fixed for life of loan. Source: studentaid.ed.gov
4) Mortgage debt. Mortgage debt is considered the least egregious debt because it’s tied to an asset that historically appreciates. Not only that, the American government allows you to write off all mortgage interest on debt up to $1,000,000 plus the interest on $100,000 of a home equity line of credit. The government allows for tax free profits of up to $250,000 for individuals and $500,000 for married couples if you live in your property for two out of the last five years. Finally, the government allows you to defer taxes by allowing you to use the sale proceeds to buy another property under the 1031 exchange program.
Take a look at this US housing price chart by Zillow and The Economist. The clear trend is up and to the right with some cyclical downturns on the way. The massive gap in price performance between Dallas / Houston and other major cities is one of the biggest reasons why I’m buying heartland real estate. With the remote work trend, technology, and strong job growth, I believe the spread will narrow.
Source: Zillow, The Economist
You want to be on the right side of a tank, inflation, the Fed, and the government. The government is pro-housing so you might as well take advantage. You’ll want to pay off your mortgage before you no longer have the desire or energy to work. For those of you who’ve been waiting to refinance or take out a loan after the rate ramp post Trump victory, now is probably time to inquire about the latest rates. See the chart below.
Average mortgage interest rate, Source: FreddieMac
Debt Is A Tool For Financial Freedom
For those who don’t have debt, I commend you for living so fiscally responsibly. The feeling was incredible when I paid off one of my rental property mortgages in 2015. Despite a further rise in the stock market since, I have no regrets.
But to shun debt completely when you’re still trying to build your financial nut is a sub-optimal move. If you can borrow for cheap and earn a greater return on your money, such arbitrage should be pursued until you have enough.
In an upcoming post, I’ll introduce my Debt Optimization Framework to help people achieve greater wealth while minimizing the chances of financial destruction.
Readers, do you agree with my debt rankings? What do you think about taking on debt to achieve financial freedom sooner? Is that an oxymoron? Why do people have revolving credit card debt when the risk-free rate of return is only ~2.5%?