Debt is a huge problem in the United States. A recent survey revealed that, of households carrying debt, the average amount owed was $132,000. More specific data shows that for households holding the following types of debt, the average balances were:
Mortgage Debt: $171,775
Credit Cards: $15,310
Auto Loans: $27,188
Student Loans: $48,986
So to help you wisely manage debt, with the goal of eventually eliminating it, here are the 10 smartest things ever said about debt:
(1) Debt & Happiness: “If there is any one thing that will bring peace and contentment into the human heart, and into the family, it is to live within our means. And if there is any one thing that is grinding and discouraging and disheartening, it is to have debts and obligations that one cannot meet.” – Heber J. Grant
Income level is not highly correlated with happiness, but debt level is. Think long and hard before going into debt, and if you already have debt paying it off will likely do more to contribute to your future happiness than just about anything else.
(2) Interest Never Sleeps: “Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never visits nor travels…it has no love, no sympathy; it is as hard and soulless as a granite cliff. Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, nor orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.” – J. Rueben Clark
The reason excessive debt is so discouraging and disheartening is because interest never sleeps. The reason it is so difficult making progress getting out of debt is because interest never sleeps.
Author Richard Paul Evans, whose family lost their house due to financial difficulties when he was growing up, tells the story about his father calling a family meeting. He announced, “I’ve spent the last three days figuring out why, after all these years of hard work, I have nothing to show for it but bills. Do you know where it all goes?” When no one answered, he stated, “It goes to interest. All those heartbeats went to paying interest to make someone else rich.”
Additional Reading: When it Comes to Debt, Are You Smarter Than an Octopus?; The Greedy Snake: A Debt Parable
(3) Back from the Future: “The essence of finance is time travel. Saving is about moving resources from the present into the future. Financing is about moving resources from the future to the present.” – Matt Levine
“…every time you borrow money you erode your future income…” – Daniel Solin
I love the idea of viewing modern finance as an industry that provides us the tools we need to send our money on time-traveling adventures. I think this is a very powerful, personal, and accurate model to use in making financial decisions.
Every time you borrow money you are, in reality, asking a future version of yourself to send money from the future back to the present. This might be acceptable under certain circumstances, such as buying a reasonably priced house that the future you can also enjoy or educating yourself in a way that will increase the earning potential of your future self. Other times it is simply selfish, such as spending more than you can afford on a “dream car” that the future you will still be paying for when it is anything but a dream car. Wise use of debt means not asking your future self to sacrifice unduly for your present self.
Additional Reading: Back to the Future: Money and Time Travel
(4) Stop Digging: “The first law of holes: When you are in one, stop digging.” – Attributed to Will Rogers among others
If you are in debt, and are serious about eliminating it, the first step is to not take out any more loans. Make a firm commitment to not use debt in the future, devise a realistic plan to live within your means, and make whatever sacrifices are required to make it happen.
(5) The Magic Pill: “If, magically, the stores could invent a pill that they could give to their customers that would get them to buy more, it would be invaluable to increasing profits. Curiously, such a pill has been invented….The name of this magic pill is the credit card.” – Robert Shiller and George Akerlof in their book Phishing for Phools
Numerous studies back up the assertion by Shiller and Akerlof that we spend more when we use credit cards. The reason is because credit cards take away the pain of spending. Curiously, in addition to their painkilling effect credit cards also cause amnesia. In one study 30 people were asked to estimate their credit card balance prior to opening their monthly statements. All 30 of them underestimated the balance, and not by just a little – the average estimate was 30 percent below the actual balance. Be extremely careful with credit card use. Even if you pay the balance off every month you are likely spending more than you would if you didn’t use credit cards at all.
Additional Reading: What Do Credit Cards and Mosquitoes Have in Common?
(6) A Personal Finance “Never”: “There is no way you can get ahead of the game if you are paying 18 percent a year interest on your credit card. Soon your monthly payments will barely be able to keep up with your interest payments, and your balance of indebtedness will never go down. There are few ‘never’ rules in personal finance, but the one I recommend is: Never allow yourself to build up credit card debt. And if you do have credit card debt, your first step to financial security should be to get rid of that debt as soon as possible.” – Burton Malkiel in his book The Random Walk Guide to Investing
Carl Richards adds, “Imagine if I offered you an investment opportunity that had a guaranteed return rate of 15, 18, or even 22 percent. I suspect that, even if money were a little tight, you’d find a way to get in on the ground floor. And yet, if I told you that you could make the same amount of money by paying down your credit card debt, you’d probably find a number of excuses why that just isn’t possible right now.”
The bottom line: Avoid credit card debt if at all possible, and if you already have it do whatever is necessary to pay it off. Nothing will improve your financial situation quicker.
Additional Reading: Credit Card Debt is Where Financial Dreams Go to Die
(7) The Shortest Path to Wealth Building: “They [cars] are the largest purchase “normal” people make, and they drop in value the second you drive them off the lot. Cars do more financial damage to middle-class Americans than almost any other financial decision. Paying cash for a car and buying a used one is the shortest path to wealth building.” – Dave Ramsey
Auto loans are among the worst types of debt because cars depreciate so quickly. If you take out the typical auto loan of 60-72 months you will still be paying on the loan when the car is worth only a small fraction of what it cost you. Ramsey adds a useful rule of thumb for the maximum you should spend on cars: “The value of all your automobiles should be less than half of your annual income.” If you spend less on cars, and pay cash, it will free up money to purchase assets that grow in value instead of depreciating, thus creating wealth instead of destroying it.
Additional Reading: Cars are the Great Middle-Class Wealth Destroyer
(8) Home Buying Lunacy: “What you can afford has little to do with what a mortgage broker will lend you for your house…, what a credit card company will lend you, or whether a bank will qualify you for a new car loan…Just because you take out a mortgage for 20% less than the maximum amount that the bank or mortgage broker is willing to loan you does not mean you are being financially prudent – 20% less than lunacy is still lunacy.” – Ronald T. Wilcox
Buying a home you can afford can be a wise use of debt. However, don’t rely on lenders to tell you how much you can afford to borrow. You are the expert on your finances. Do your own analysis, and be conservative. In their landmark book The Millionaire Next Door, Thomas J. Stanley and William D. Danko provided a useful rule of thumb: “If you’re not wealthy, but want to be someday, never purchase a home that requires a mortgage that is more than twice your household’s total annual realized income.”
(9) An Educational Ferrari: “When you could pay your way through college by waiting tables, the idea that you should ‘study what interests you’ was more viable than it is today, when the cost of a four-year degree often runs to six figures. For an 18-year-old, investing such a sum in an education without payoff makes no more sense than buying a Ferrari on credit.” – Glenn Harlan Reynolds
Education is vital, and it has value apart from simply helping you make money. However, when you have to take out loans to complete your education the equation instantly changes. Like it or not, at that point it becomes primarily a financial decision. The value of the education you are buying must be worth more to you in future earning power than what you are borrowing, and you need to do a clear-headed analysis to determine if this is true. If it is not true, study something else, study at a different school, work while going to school, save in advance, or come up with another plan. Do not borrow for an education unless it gives you a clear future financial advantage far greater than the debt you are incurring.
Further Reading: Ask (and Answer) the Right Questions Before Taking Out Student Loans
(10) Indecent Exposure: “Only when the tide goes out do you discover who’s been swimming naked.” – Warren Buffett
When things are going well you might be able to keep up appearances by incurring unwise debt, but when difficult times come – as they always do – you will be left painfully and embarrassingly exposed.
The solution? Manage your debt wisely before the tide goes out by:
- Avoiding credit card debt. If you already have credit card paying it off should be your number one financial priority.
- Buying used cars and paying with cash if possible. If a loan is necessary take it out for the shortest term possible.
- Buying a home you can afford. Decide yourself how much you can afford. Don’t let the mortgage lender decide this for you.
- Only taking out student loans if the advantage in future earning power from the degree you are pursuing far exceeds the loan you are taking out.
Above all, before you go into debt remember that interest never sleeps, and will be your constant companion until the debt is paid. Consider your future self. While debt can be a useful tool it can also be dangerous. Use it wisely!