Debt has become so common in our society that many people couldn’t imagine life without it.
How else do you go to college? Buy a house and a car? Take a vacation? Pay for braces? Weddings? Christmas?
We’ll go into debt for almost anything just so we can have it now. We’re so used to getting what we want as soon as we want it.
Want entertainment? Just grab your phone or flip on the TV.
Want new shoes? Use 1-click checkout and same day delivery on Amazon.
Hungry? Toss a container in the microwave or hit speed dial for delivery.
All of this convenience is great. But immediate gratification is a huge problem when you can’t afford it. Getting out of debt and building wealth are about delaying gratification, which is why so many people have trouble doing it. It’s the opposite of what our culture and advertisers tell us we really want!
Here’s what consumer debt—credit cards, auto loans, and student loans—does to hold you back from a great financial future, and why you need to get out of debt now.
Debt keeps you from saving and investing
When you have debt, your hard-earned money goes toward servicing your debt payments. Every dollar spent on debt is a dollar that can’t be saved and invested. In other words, it’s making you poorer!
Do you know what you can do when you have savings? You can buy stuff without debt!
Get out of debt before buying stuff you don’t need.
Once you’re out of debt, at least you can afford it.
You may be thinking, “the minimum payment on my credit card is only $30 a month. It isn’t that big a deal.” Wrong. Even small contributions to a retirement account add up to big numbers over time.
A $30 monthly investment in an index fund making 10% a year is worth $68,678 after 30 years. That’s a 536% return on your total contributions of $10,800. Now it’s starting to sound like a big deal, isn’t it?
What if you stay in debt just one extra year, then save for 29 years? You’ve only saved $360 less. But your ending balance is $6,877 lower. That means those $30 payments in year 1 would have returned 1,810% by year 30!
Don’t wait any longer to pay off debt.
Every month is costing you thousands of dollars in lost investment opportunity.
But wait. We’re only talking about minimum payments here. You also have thousands of dollars of debt accumulating interest that you eventually need to pay off before you can get investments working for you.
Debt is compound interest for the lender instead of you
Minimum payments aren’t enough to pay down debt in any reasonable time. If you only made minimum payments, it can take 30 years to pay off a credit card balance. You’re in the habit of using credit cards when you can’t afford them, though. So it’s easy to just max out your credit balance as soon as it opens up.
The last example showed compound returns on a $30/month investment. The math works exactly the same—but in the opposite direction—for lenders.
The average credit card interest rate is 16.65% as I write this. At that rate, a balance of just $2,162 would cost $30 in interest each month. If you keep that balance around, they can take that $30 each month and lend it to someone else at 16.65%. Even better than the 10% you can get in the stock market. Your $30 payments turn into $306,354 for them after 30 years!
That’s right. They loaned you $2,162 for 30 years, you paid them $10,800 in interest, and they turned it into $306,354 by loaning it out to others.
It’s no wonder the biggest buildings in most cities are financial institutions.
Interest on debt is making them rich!
Here’s a table to make sure this sinks in.
Stop making the banks rich. Start getting rich yourself by paying off your consumer debt and then investing for your future.
What if the interest rate is low?
“But the bank is giving me an introductory rate of 0%!” you say. “And my car loan is 0% too. What’s wrong with that?”
The lenders aren’t a charity. They only do this because they know they’ll make a profit somehow. Either they’ll hit you with a larger rate later. Or they gave you that rate because you spent more than you should have on that car.
The 0% financing “deals” from car manufacturers are there because they sold you a new car that loses 10% of its value as soon as you sign the papers. Buy a 1-year-old car and you’ll pay about 20% less for almost the same car. Then take that extra money—if you have it—and put it to work in the stock market.
Let’s say a new car costs $30k and you could buy a one-year-old model for $24k. But the dealership is giving you 0% financing on the new car. The used car would be financed at 8.6%. The new car sounds like a pretty good deal, right? According to the following table, the used car still costs almost $5k less after all payments are made. And you would have more than $6k invested if you took the $82 you saved in payments and invested it at 10% for 5 years.
Zero down and 0% financing won’t make you rich. But it might keep you poor.
Summary
You need to get out of debt now if you want a better financial future. Every month that you stay in debt is another month of lost wealth for your future self.
Debt keeps you from saving and investing. It makes the lender rich while keeping you poor. And it encourages you to spend more because it doesn’t appear to cost much on the day you buy it.
Read this article next for strategies to help you start paying off debt.
And don’t forget to sign up for FREE at the bottom of the page to get much more value from PathwayToFI.
Join me on the Pathway to FI!
