Intelligent
Borrowing or Stupid Debt (Part 1 of 3)
By =
Mary
Hunt
The
only thing worse than investing in things that depreciate is paying interes=
t on
money invested in things that depreciate.
Blaine Harris
=
Not
all debts are created equal, nor is every type of loan hazardous to your
wealth.
=
There
is a world of difference between a home mortgage and a revolving credit card
balance. Both are liabilities for which the borrower is legally responsible.
The first I call intelligent borrowing, the latter is stupid debt=
.
=
Those
who are living debt free and are debt-proofing their lives would sooner poke
toothpicks under their fingernails than live in the grip of stupid debt. Th=
ey
participate only in intelligent borrowing, if at all.
INTELLIGENT
BORROWING
=
Intelligent
borrowing means that some level of safety and limited risk for both the len=
der
and the borrower is built into the transaction. Here is what intelligent
borrowing looks like:
=
1. The
borrower has a safety valve—a legally and morally sound alternative t=
o get
out of the obligation.
=
2. The
debt is secured. The lender holds something that is at least as valuable as=
the
amount of the loan, something known as collateral. Think of collateral as a
security deposit for the lender.
=
3. The
loan is for something that has a reasonable life expectancy of more than th=
ree
years as opposed to something that will be down the drain before the bill
arrives.
=
4. The
loan is for something that will increase in value, unlike a couple of movie
tickets and dinner in a fancy restaurant or great new outfit.
=
5. The
interest rate is reasonable.
=
The
best example of intelligent borrowing is a real estate loan or home mortgag=
e.
Let's see how it measures up to each of the intelligent borrowing
characteristics:
=
1. Is
there a safety valve or escape route? Yes, there is a way of escape for both
the borrower and the lender. If you, the borrower, find you just can't hand=
le
those high payments or you want out for any other reason at all, you can se=
ll
the house and pay the lender from the proceeds of the sale. Because the loan
becomes an asset for the lender, he can sell his position.
=
2. Is
the debt collateralized? Yes. With a mortgage, the real estate is the
collateral—the lender's security. The lender has a legal lien on the
property until the mortgage is paid in full, and that gives him a legal
position in the transaction. If you as the borrower do not hold up your end=
of
the bargain to which you agreed, the lender may take the property as payment
for the outstanding loan.
=
3.
Does the purchase have a reasonable life expectancy of more than three year=
s?
Yes, of course. This is true not only for the structure itself but also for=
the
land on which it sits. Buying a home is a long-term investment.
=
4.
Will it increase in value over time? Yes. Real estate is always considered =
an
appreciating asset even though specific values may decline during economic
cycles. As a general rule, real estate always gains in value over time.
=
5. Is
the interest rate relatively reasonable? Yes. In nearly all situations,
mortgage rates are lower than other types of consumer loans, usually by as =
much
as two-thirds.
Remember,
all debts are NOT created equal. Click here to =
read
Part II about "stupid debt."
Ta=
ken from
Debt-Proof
Living: The Complete Guide to Living Financially Free by Mary Hunt.
Copyright © 1999. Used by permission of Broadman<=
/span>
& Holman Publishers. All rights reserved.
Stupid
and Beyond-Stupid Debt (Part 2 of 3)
By =
Mary
Hunt
This is the kind of =
debt
you agree to, often impulsively, when your desire is in high gear and your
brain is in neutral. It is so easy—much too easy.
While there are many=
ways
to rack up a pile of debt, credit cards are by far the most popular. Almost
anyone these days—even high school students—can get a credit ca=
rd.
There's no qualifying process to speak of, no long applications to fill out=
or
references to submit. Students don't even need a job or a cosigner.
Someone with a credi=
t card
and available credit limit can in effect take out very expensive loans on a
whim and at nearly every place, including cyberspace. You simply make your
decision, swipe the magic plastic, sign your name, and presto!—you've
made a very long commitment to stupid debt. Painless? Sure, it is in the
beginning. But not for long, my friend. Not, for long.
Let's say you use yo=
ur
credit card to acquire the very latest computer, complete with scanner, fax
modem, jumbo monitor, DVD player, turbocharged CD Rom, and—the best
part—a free printer. It's on sale (which to many naive consumers is a
clear sign of providential entitlement) and you want it right now. Why shou=
ld
your lack of cash prevent you from making this really good deal? (Remember =
the
free printer.) You have plenty of room on your account to cover it.
As you haul that bab=
y to
the car, the last thing on your mind is how you will actually pay for it. Y=
ou
didn't consider for one second how this new debt will affect your current
payment structure. It can't be that bad, you reason, because you got approv=
ed.
And you get a free printer!
Let's see how this
purchase measures up against the criteria for intelligent borrowing:
1 . Does the borrowe=
r have
a way out at any time? No. If you don't pay as agreed, the credit card comp=
any
won't come after the computer—they'll come after you. Unless you can =
sell
the computer for what you paid for it (fat chance), you have no way out.
2. Is the debt
collateralized? No. The credit card company is holding nothing of value to
fulfill this debt if you are unable to pay. But they've got a tight grip on
you. They don't want that computer or anything else you buy with a credit c=
ard,
for that matter. This loan is unsecured.
3. Does this purchas=
e have
a life expectancy of at least three years? No matter how you cut it, a
three-year-old computer is not exactly cutting-edge technology. By its third
birthday it has little monetary value even though it may still compute. In
fact, that paragraph I wrote only moments ago listing the features of this
machine is already out-of-date. Just think about that for a minute!
4. Will it appreciat=
e in
value? From the minute you walk out of the store, a computer is in the fast
lane to obsolescence. It's depreciating with every click of the mouse.
5. Is the interest r=
ate
reasonable? No. As of this writing, the average credit card annual interest
rate is 17.8 percent, while a thirty-year fixed-rate mortgage is 6.79 perce=
nt
per year.
The computer purchase
fails the intelligent borrowing test miserably by getting a "no"
response to all five questions. Paying for a computer over time cannot qual=
ify
as intelligent borrowing, and if paid for with a credit card or other form =
of
consumer credit, it would qualify as a stupid debt.
ANATOMY OF A STUP=
ID
DEBT
Let's say this compu=
ter
deal we're analyzing has a price tag of $2,000. The credit card terms are
typical: 17.8 percent interest with minimum monthly payments of 3 percent of
the outstanding balance. I just plugged those figures into my Minimum Payme=
nt
Credit-Card Interest Calculator' and—hold onto your floppy disk—=
;it
will take 13 years and 9 months to pay the total price tag of $3,759, inclu=
ding
interest. Did you get that? Thirteen years to pay nearly twice the purchase
price for a computer that will be functionally obsolete in much less than h=
alf
the time. There's no other way to characterize such a transaction than pret=
ty
stupid.
What will make thing=
s even
worse is if, after two or three years, you decide to upgrade to a new compu=
ter
even though you still have ten years to pay on the first one. Nevertheless,=
if
the credit is available, it is quite easy to add another purchase (like a n=
ew
computer) to the growing load of debt.
In no time at all, t=
he
forever revolving credit card balance is not seen for what it really is (a =
very
high-priced loan on a lot of stuff you might not even own anymore) but rath=
er
as a normal part of life—like the rent, phone bill, and cost of food.=
In
fact, I could show you high school personal finance curriculum that suggests
keeping consumer debt at a manageable level, not to exceed 20 percent of in=
come.
I find that somewhat outrageous.
BEYOND STUPID
While the computer e=
xample
is remarkably illogical, other kinds of stupid debt make the computer scena=
rio
appear somewhat reasonable. Turning restaurant meals, travel, groceries,
utility bills, movie tickets, vacations, gifts, gasoline and school clothes
into debt and then choosing to pay for them with minimum monthly payments o=
ver
many years and at rates that effectively double the original costs brings n=
ew
meaning to the term stupid.
Spending money you d=
on't
have yet to pay for things you don't have anymore is anything but intellige=
nt.
Nevertheless, that is exactly what millions of people in the country are do=
ing
every day, every month, year after year after year.
Now that you know=
what
stupid and beyond-stupid debt is, Mary explains semi-intelligent or semi-st=
upid
debt. Click=
here
for Part 3.
Ta=
ken from
Debt-Proof
Living: The Complete Guide to Living Financially Free by Mary Hunt.
Copyright © 1999. Used by permission of Broadman<=
/span>
& Holman Publishers. All rights reserved.
Semi-Intelligent
or Semi-Stupid Debt (Part 3 of 3)
By =
Mary
Hunt
As you know, a home
mortgage qualifies as intelligent borrowing because it limits risk for both=
the
borrower and lender and is fully collateralized—at least it's suppose=
d to
be that way. The homeowner can borrow only up to a certain limit, so the le=
nder
has reasonable assurance that the property has a current market value more =
than
the outstanding loan.
HOME EQUITY LOANS=
A home equity loan,
curiously known in the industry as HEL, is typically a second mortgage that
positions itself in such a way to allow the homeowner access to the equity
(that margin between what is owed and what the property is worth). Equity is
the borrower's asset—and a precious asset at that.
A HEL opens a large = line of credit for you, pledging your equity as the collateral. You can borrow against it whenever you want. Technically it is a secured debt because of t= he collateral feature. And the borrower's safety valve remains because the home can be sold to satisfy both of the debts. But it can be very risky—and that is when it can cross over into stupid territory. There are five ways t= he stupid factor can sneak into an otherwise intelligent mortgage situation: <= o:p>
1. If you borrow aga=
inst
your equity to clean up your credit card debt and then run up your credit c=
ards
all over again, that leaves you with twice the debt—the equity line a=
nd
the credit cards. Not smart.
2. Some people treat=
a
home equity loan as a permanent debt to be paid off when the house is sold.
They might have felt a greater urgency to pay off the debts if they were in=
the
form of credit card balances.
3. The convenience of
having your home's equity available at your fingertips can be a formidable
temptation. Knowing the money is readily available, you are more likely to
fritter it away on something, like a well-deserved family vacation, instead=
of
saving the money first as you might have if you did not have such easy acce=
ss to
your precious equity.
4. If you are unable=
to
keep current on both of your mortgages, either of the lenders can foreclose=
.
Sometimes the home e=
quity
loan and first mortgage together actually exceed the current market value of
the property. There are lenders these days who offer to finance not only the
full value of the home, but more than the property is worth. These 125-perc=
ent
loans put the borrower in a tenuous position—the monthly payments are
severe, but selling the property ceases to be a way out because more is owed
than it would bring at sale.
Even taking into
consideration the fact that the interest on the home equity loan may be
deductible from your taxable income, the risks involved with this potential=
ly
stupid debt can be weighty.
The equity in your h=
ome is
an appreciating asset, for many people their only appreciating asset. If you
leave it alone, it will grow as the property becomes more valuable and as y=
ou
pay down the mortgage. That contributes to the intelligence factor of your
home's mortgage. To muddy those waters with a HEL opens the door to stupid
debt.
AUTOMOBILE LOANS<=
/span>
A car loan can conta=
in
elements of intelligent borrowing provided you make a large down payment and
select a model that historically retains high resale value. An automobile l=
oan
is a secured debt; if you get into some kind of trouble, you can sell the c=
ar
to repay the debt. Cars do not appreciate, however, so not all of the
intelligent borrowing criteria apply.
A car loan can slide=
over
to the stupid debt area if you put little or nothing down and stretch the
payments past three years. It won't take long for you to be "upside
down" in the loan, meaning you owe more than the car is worth. Borrowi=
ng a
car for a long period of time, also known as leasing, is in most situations
anything but intelligent. Getting caught on the leasing treadmill can be a =
very
expensive proposition.
STUDENT LOANS
If ever there was a =
gray
area in this matter of intelligent borrowing versus stupid debt, it has to =
be
the troublesome student loan.
Some argue that a st=
udent
loan qualifies as intelligent borrowing because the resultant education will
appreciate over time and will more than pay for itself in future income.
Nevertheless, that is making some bold assumptions: first, that you will ac=
tually
finish school; second, that you will be well suited for the field in which =
you
are getting your degree; and third, that the field will welcome you. I find=
it
just short of amazing that 85 percent of college graduates do not end up
working in their major field of study. (But then I recall the decisions I m=
ade
at that tender age, and I understand fully.)
Whether student loan=
s fall
into the category of semi-intelligent or semi-stupid has a lot to do with o=
ne's
individual circumstances.
RECOGNIZE THE SIG=
N OF
DEBT
It is not difficult =
to
recognize the difference between intelligent borrowing and stupid debt:
As a person desiring to debt-proof your life, your mis=
sion
is to rid your life and your future of all stupid debt, to borrow money only
when it cannot be avoided, and then to do so as intelligently as possible. =
The trouble with debt can be likened to the proverbial
frog in the pot of boiling water. If you try to pop him in once the water is
boiling, he'll jump out. But if you start him out in cold water and slowly
raise the temperature, he'll just sit there and cook to death.
People are like that frog when it comes to stupid debt=
. We
wouldn't jump into the boiling water by purchasing something really big and
expensive, like a car or boat, with a credit card, but months and years of
consistent spending for smaller purchases while paying only the minimum pay=
ment
each month allows the temperature to rise ever so slowly. Before we know it,
we've reached the boiling point.
Stupid debt doesn't usually start out stupid. In the
beginning it is simply a matter of convenience. You pay the entire balance
during the grace period. Then one month the balance is a little larger than=
can
be easily paid, so you pay half and plan to pay the balance next month. But
then something comes up and it appears to make sense to lot it roll over in=
to
the next month. Soon you're hooked with a balance too large to pay in full =
in a
single month, and you're on your way. The water started boiling and you were
completely unaware.
So why is debt such a problem?
1. =
Debt promo=
tes
discontentment.
When you're charging things with money you don't have, you are not content =
with
your income. You cannot be patient. You cannot wait. You have to have it ri=
ght
now! But when you acquire things too easily without pride of ownership, it =
is
easy to become dissatisfied quickly.
2. =
Debt makes
arrogant presumptions about the future. By agreeing to have things no=
w and
becoming legally obligated to pay for them later, you make bold presumptions
about what the future will hold in terms of money, ability and health. What
makes you believe that although you don't have the money now you will have =
it
later? But worse, you also promise that you will be willing to turn over mo=
ney
you don't have yet to pay for things you may not have anymore. What makes y=
ou
think you will be all that thrilled about spending money you've not yet ear=
ned
for stuff you probably won't even remember? That's an arrogant attitude and=
an
irresponsible presumption on the future.
3. =
Debt requi=
res you
to transfer your future wealth to your creditors. If given the choice of sendi=
ng
monthly support checks to the wealthy credit card industry or sending those
same checks to build your own future, would you really choose the former?
Probably not. However, when you agree to stupid debt, that is exactly what
you've done. Your choice has been made, and there is no way out but to make
full repayment, no matter how difficult or unreasonable that will be.
4. =
Debt limit=
s your
options—and heavy loads of debt eliminate them altogether. Debt keeps people tied to job=
s and
careers they hate. It forces moms who would rather be home with their kids =
to
work outside the home. It can even give Mr. Right second thoughts about tak=
ing
on a prospective bride because of her heavy, debt-ridden baggage.
5. =
Debt steal=
s your
freedom and makes you a slave. When you are under a load of stupid debt, you are in
bondage. You have no way out but to work off your sentence. King Solomon, t=
he
wisest man ever to have lived, summed it up this way: "The rich rule o=
ver
the poor, and the borrower is the servant to the lender" (Prov. 22:7).
Ta=
ken from
Debt-Proof
Living: The Complete Guide to Living Financially Free by Mary Hunt.
Copyright © 1999. Used by permission of Broadman<=
/span>
& Holman Publishers. All rights reserved.
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Mary
Hunt has written many books concerning wise financial planning. Here she
takes a look at the foundational principles to steer toward when climbing=
out
of the hole of debt. |