A major US Bank, a large vehicle financial firm and a student loan servicer own me.

Okay, so maybe that is a strong statement. They don’t really own me, but they sure do dictate what I do on a monthly basis. “Just as the rich rule the poor, so the borrower is servant to the lender” Proverbs 22:7.

My debt is fairly mundane. We have a mortgage, a small car payment and a little bit of remaining school loans from our bachelors degrees. Over the next two years or so this should all be reduced to just the mortgage. I don’t carry any credit card debt, and generally speaking we prefer to buy things in cash.

Why is all of that important, and more importantly why should you care? Well, you probably don’t care about my debt, but you really should be focused in on your own and getting out of it!

Let me qualify that last statement… Not all debt is bad debt. In a lot of cases you can borrow money to purchase an asset that will result in positive cash-flow, when that happens, that is generally good debt. All other debt is bad* and you should try to get the heck out of it as soon as possible.

* There are folks that will disagree with me on this point. They will counter with the fact that most folks cannot purchase a home with cash, therefore their mortgage is good debt. I’m not going to spend a lot of time arguing with people about that - my stance is with Robert Kiyosaki. Since my mortgage costs me money it is bad debt. I have a mortgage (so does Kiyosaki), and will continue to have one, it is still not good debt.

So why is debt bad? I mean, if I can afford the monthly payment then who really cares right? Wrong! If you are saddled with a monthly payment your actions are dictated by the owner of your debt (and your stuff).

Let’s take a hypothetical situation where you purchase a brand spanking new car. For sake of argument let’s pretend that the car costs you $30,000 and are able to buy it no money down. The whole thing is financed at 8% for 6 years and your monthly payment is going to be $526.00 a month.

• Initial Loan Amount: $30,000
• Interest Rate: 8%
• Term: 6 Years (72 Months)
• Monthly Payment: $526.00

So in our little scenario we are able to get this fantastic new car for only $526.00 per month! On the surface that may not be so bad, if you have the cash-flow to support the debt; however, lets peel back the onion a little bit.

First off, debt costs money. If you are not making positive cash-flow* as a result of your debt, then it is costing your money. In our car example, the final price of the car will be $37,871.80, or 26% more than the original purchase price. Since the car doesn’t pay you each month, it is bad-debt.

* I’m talking about hard cash in your pocket. Income less all expenses = cash-flow. This isn’t some goofy accounting calculation like IRR, or NOI or any of that other stuff. This is the money that hits your pocket book. You cannot count on things like appreciation. Just take a look at the current housing market. Potential appreciation is a very nice thing that typically happens, however if your investment does not throw off positive cash-flow, and requires debt to purchase, it is not a good investment.

If you don’t believe me try this: Go to the bank, ask the banker for $100,000 so that you can invest in the stock market or buy mutual funds. You are about 99.9% likely to walk out with a bruised ego and no more money in your pocket than you had when you walked in.

Next, by paying someone else you are given away your potential returns. For sake of argument let’s pretend that you could invest your $526 per month and earn 8% on it. At the end of 72 months that investment of $526 per month would be worth approximately $43,000 (Depending on your tax rate). That is a full $13,000 more than you would have had to pay for the car in the first place. Had you been investing that money rather than spending it paying for the debt, at the end of 72 months, you could be almost half way to a cash purchase of another new car - without spending any more money!!!

Third, what if something happens? If you lose your job, have an unexpected major expense, or any number of things you may really need that $526 to help pay for something. After you get off the phone pouring your heart out to the finance company asking for extensions etc… you will still need to pay $526 that month. Your big expense will likely have to be financed, by another loan, and will have costs associated with it as well. Thus begins the viscous cycle of bad debt.

This is the cycle that is just beating down a lot of consumers today. Think about it this way. If you have to finance an unexpected cost, and that finance charge is $50 a month you have effectively lost $50 per month in cash-flow until it is paid off. If that were to happen to you twice a year for the next 3 years you’d have lost approximately $300 per month in cash-flow while you pay off your debts. This cycle can easily continue until you can no longer meet your monthly obligations to you creditors - that is an ugly place to be in.

So… bad debt is no good. It inflates the price that you pay for something, takes away your potential future interest income on your cash, limits your flexibility on a month to month basis, and has the possibility to throw you into a financial tail spin. I don’t know about you, but I don’t really like the feeling of being owned by someone else. Having my actions dictated by others based upon my indebtedness is no fun at all. Debt sucks. Get out of it.

Getting out of debt is easier said than done. However, getting out of debt is not impossible! I’ll talk about this a little bit and go through my own experiences as I’ve paid down mountains of consumer debt over the past few years.

Categories: Personal Finance