Everything About Debt

TL;DR

Debt is “renting” money from other people, using the terms of a loan to specify how much the rent will cost.

There are many things that debt companies don’t want you to believe:

  1. Nothing is ever “good” to go into debt for, though some things are worth it if you can make more money from it in the long run.
  2. Debt incentives are never worth the cost in interest payments.
  3. Investing doesn’t require a good credit score, only debt.

The only way to morally escape debt is to overpay every month.

What is debt?

Debt is essentially “renting” money:
  1. A borrower asks a lender for money and gives something as “collateral” for it (e.g., borrowing $1,000 for a ring worth $400).
  2. The lender gives that amount (“principal”) with a specified interest rate (e.g., 10%) as “rent” (“interest”).
  3. At a specified interval (usually monthly) the lender calculates the remaining principal and interest for the borrower and asks for a monthly payment.
  4. As the borrower pays off the principal, the interest amount goes down, which makes either the lender’s minimum payment go down or the next payment made of more principal than before.
  5. Since monthly payments are typically the exact same across the life of the loan, most of the early payment goes straight to interest.

A. A loan contract puts several things in writing:
  1. The loan amount
  2. The interest rate
  3. How frequently the interest rate hits the remaining balance
  4. The minimum payment the borrower has to make

B. The lender expects a minimum payment:
  1. Not paying or underpaying will often incur late fees.
  2. Any overpaid amount goes straight to principal.
  3. The remaining balance is re-amortized.

C. Loans with higher balances often stagger payments toward interest:
  1. The lender assumes the borrower will make minimum payments and calculates all future interest (e.g., $1000 at 10% across 65 months is $299).
  2. Most of the first payments go almost entirely to interest (e.g., Month 1’s $20 puts $19 to interest and $1 to principal).
  3. Overpayment goes to principal, assuming the loan hadn’t specified different terms (Month 2’s $30 sends $19 to interest and $11 to principal).
  4. Near the end of the loan’s life, the principal is a larger portion of the payment (Month 40’s $20 directs $4 to interest and $16 to principal).
  5. This staggered payment ratio makes minimum loan payments dramatically more expensive than paying it off early.

Debt companies market lies

They make trillions on debt, so they spend billions to advertise.

These lies have been around for decades to where refuting them is often offensive:
  • Consumer debt is always a product designed to fulfill instant gratification, no matter how it’s pitched.
  • A household that makes routine credit card payments as a type of “bill payment” are in a state of financial crisis.
  • Owning a credit card creates an inherent risk, not an inherent security.

A. Nothing is ever “good” to go into debt for

Society always saw debt as universally bad until “good debt” was advertised in the 1960’s.

Debt guarantees increasing stress and risk proportional to the amount the person is borrowing.

Loan consolidation is bad for several reasons:
  1. Debt consolidations usually roll lower-interest loans into them.
  2. Borrowing from A to pay off B changes the debt owner and can create unforeseen consequences.
  3. Smaller debt payments compound more interest.
  4. A freed-up line of credit feels convenient to use.
  5. Paying off one colossal loan is more daunting than many smaller loans

Never cosign a loan:
  • If someone needs a cosigner, the lender deems that person unlikely to pay.
  • If they don’t make a payment for any reason whatsoever, collectors will chase you down.

Lenders market financing (a sophisticated term for debt) as a tool for “necessary” purchases:
  • Companies make much more money from borrowers than straight purchasers.
  • Borrowing against any item that depreciates over time (e.g., furniture, mattresses, luxury items) creates additional risk.
  • Sell and avoid buying anything that take more than 18-24 months to pay off.

Automobiles don’t need financing to purchase:
  • New vehicles lose about 60% of their value in the first four years.
  • Most self-made millionaires drive 5 to 15-year-old used cars.

Payday loans are especially egregious, and have extortionate fees and and insane rates.

Only 3 forms of debt are ever legitimately a good idea:
  1. Home loans:
    • The mortgage should be within 25-50% of your income.
    • The housing market shouldn’t be overly inflated.
    • Research before considering.
  2. Education:
  3. Business loans:
    • You should have a good business plan before you start asking for money, as well as a plan on what to do if you fail.

B. Incentives aren’t worth the cost

Lenders sweeten their debt product sales with rewards programs and incentives:
  • T-shirts and coffee mugs are worth far less than 1 maxed credit card payment.

Scientifically, we spend more with credit cards from the increased degree of emotional separation from our money.

Accumulating points isn’t an investment or particularly savvy:
  • Reward points often expire before they’re used.
  • Many rewards program points have limits and expiration dates for using them.
  • Years of diligent points accumulation can be invalidated by a couple months of interest payments, even with double or triple points.
  • Donating points to charity is another incentive to attach positive feelings to debt.
  • Cashback is far less useful than cash.

Low card fees are usually not worth it:
  • 0% interest forms a habit of using a credit card as a bank account for 12-18 months.
  • No annual fees for the first year implies subsequent years won’t have fees.

Online purchases don’t need credit cards:
  • Bank debit cards are just as fraud-protected and accepted as credit cards.
  • Many third-party payment processors (e.g., Square) work just as well as debt vehicles.

C. Credit scores aren’t necessary for investment

Credit reports pull data from your past 7-10 years:
  • Demographic information:
    • Name and any other names
    • Phone numbers
    • Birthdate
    • Current/past addresses (can be adversely affected by frequently moving or filing inaccurately with the government)
  • 35% – past payment history:
    • Any bankruptcies or judgments in the past ten years
    • Bank overdrafts
    • Missing or on-time bill payments
  • 30% – debt level:
    • Credit accounts and their limits
    • Unused credit accounts that are left open
    • A manageable percentage of your income going to payments is considered best
    • If you have no debt, you can close as many accounts as you want and it won’t affect your utilization score.
  • 15% – length of your credit history – longer loan histories look better
  • 10% – new credit:
    • Credit cards, large purchases, mobile phone and rent contracts, mortgages
    • Personal loans
    • How often you apply for credit and where (less is better)
  • 10% – the types of credit – any financial associates and bank details (fewer banks are better)

3 different bureaus calculate your credit scores (Equifax, Experian, TransUnion):
  • There are technically three credit scores that come from small variations in data capture.
  • Credit scores have no bearing on financial success.
  • The only thing credit scores help with is acquiring more debt, but the information is often used for other purposes involving financial commitments:
    • Renting an apartment.
    • Getting insurance.
    • Employers use credit reports without the credit portion as a de facto background check.
  • Scoring agencies compile the three different bureaus’ data into reports:
    • The two most popular reports are the FICO Score and VantageScore.
    • You can get free quarterly reports from all the agencies with a free login.

A credit score is a measurement of how much you use and manage debt:
  • Credit scores have no bearing on financial success.
  • The only thing credit scores help with is acquiring more debt.

It’s very, very easy to get a high credit score:
  1. Only have 1 credit card that reports to all 3 bureaus.
  2. Accrue less than 10% on that credit card routinely (e.g., refueling petrol).
  3. Pay off the entire balance twice a month
  4. If you’re ever performing multiple hard inquiries (e.g., mortgage-shopping), do it within a 14-day window to make it register as 1 hard check.

In summary, debt isn’t a financial tool

If you want to build wealth, stop seeing debt as an acceptable way of life.

Debt is either a bad idea or a necessary evil:
  • Every sustaining millionaire believes debt is financial slavery.
  • Don’t purchase extra insurance on a rental car (unknown risk) with a credit card (known risk).

Most large organizations make more money on the debt than the actual product:
  • Just about every organization that sells things at scale, from automotives to airlines, makes more income from servicing debt instruments than in the products themselves.
  • Beyond the risks to yourself, getting products with debt perpetuates the cycle and allows them to make increasingly inferior products in response.

Escaping debt

The only way to escape debt is to overpay every month:
  1. Make an additional payment on top of the minimum one.
  2. Round payments up to larger amounts.
  3. Make a significant payment whenever you get a windfall like a raise or bonus.
  4. If you know your payment will be late, call the creditor before the due date to get some forgiveness from late fees.

Debt collectors are unscrupulous:
  • The collector’s job isn’t to be your friend or help you out of your situation.
  • Their job is to get the money you owe.
  • Debt collectors try to induce strong reactions of fear or anger to get a payment.
  • They often aren’t aware even if you made payments, and simply see a name and balance owed.
  • If you don’t pay them, your credit score will still have a hit (if applicable), but you’re among a vast majority of non-compliant debtors.

You do have some rights as a borrower

Lenders are supposed to go through a “dunning” process, where they start with gentle reminders, then move to threatening letters and phone calls, and may even visit your home.

Unless the lender is the government or has another contractual connection with you, a creditor can only garnish your wages or take money from your account if they sue you and win.

You don’t legally owe anything to any debt collector until the moment you’ve made any payment for it.

It’s illegal for collectors to call or harass you between 9 p.m. and 8 a.m. unless you’ve given them permission.

You have the right to demand they stop calling you at work.

You have the right to demand they stop all contact with you except to notify they’re suing you:
  • Stopping contact halts any chance of a favorable negotiation.
  • If a creditor can’t negotiate, they’re more likely to sue.
  • If they sue, they’ll likely win because you legitimately owe them money.

The only way to fight debt is with a workable budget.

This page is Part 2 of my Managing Money series. Part 1 was Why Money Management Matters.