The case for household debt freedom

Household debt freedom isn’t just freedom from household debt, Hamm writes. It’s freedom from worry.

Richard Drew/AP/File
In this May 2012 file photo, a Visa credit card is tendered at the opening of the Superdry store in New York's Times Square. Household debt freedom maximizes your personal gap between income and expenses, Hamm writes.

A couple times a week, I’ll get an email from a reader asking some variation on this question:

If I can refinance my house at 3.5% why would I ever want to pay it off early if I can earn 7% over the long term in the stock market? Debt freedom seems like a bad goal when credit is so cheap.

Even if credit is available at 0%, I argue that debt freedom is never a bad idea.

In order to explain that idea, let’s roll back the clock to 2005. In 2005, Sarah and I were swimming in consumer debt.

We had one car loan at 7% on which we had to pay $200 a month.
We had another car loan at 6% on which we had to pay $250 a month.
We had a credit card at 20% on which we had to pay $100 a month.
We had two other credit cards (around 20% each) on which we had to pay about $80 a month each.
We had two lines of consumer debt (around 20% each) on which we had to pay about $30 a month each. 

These payments added up to about $770 a month. Add on our rent of about $600 per month, our auto insurance, our commuting costs, our food, and our utilities, and our budget was on the verge of exploding.

The problem in this situation wasn’t the interest rates on those debts. The problem was the sheer amount of debt and our monthly commitment to repayment. Almost $800 per month went toward debt repayment.

If you add a house payment on top of that, it’s easy to see that amount getting into the thousands of dollars a month.

The thing is, even $1,000 a month in take-home pay has a drastic impact on one’s life situation. $1,000 in take-home pay adds up to $12,000 a year in take-home pay. Add federal income tax and state income tax on top of that and you’re easily looking at a salary impact of $20,000 a year.

A person making $40,000 a year with that debt load has the same lifestyle as someone making $20,000 a year that’s debt free.

A person that has the freedom to take a $20,000 a year job without financial suicide has a lot more peace of mind and personal security than a person who has to make $40,000 minimum to keep their head above water.

A person who can live on $20,000 a year can take enormous career risks. They can leap into a new career path without worry. They can shrug if they’re downsized and go apply for a job at Home Depot the next day.

A person who needs $40,000 to pay the bills can’t take such risks. They’re often locked into their job, and if they’re downsized, it’s a desperate situation.

Debt freedom isn’t just freedom from debt. It’s freedom from worry.

But what about the situation where you can take on debt at a low rate and invest it to theoretically earn a better rate, such as in the stock market example above?

First of all, there’s no investment that has a guaranteed return that beats the current interest rates on debt. In order to shoot for a better return, you have to take on some risk, particularly in the short term. If you buy stocks now, you could easily see a 20% loss over the next year, even if you would get that nice 7% annual return over a long period of time.

Let’s say you lose your job as a result of that downturn. Suddenly, you have debt around your neck and an investment that has purged money. That’s the risk you take if you decide to take on personal debt for investment purposes.

Second, even if you do invest that money, you’re still locking yourself into a monthly debt payment. You’re signing up to be tied even more tightly to your job than before and to having a narrower range of jobs and career paths you can take on while you hold that debt.

Debt freedom eliminates all of these concerns. It minimizes your monthly expenditures, giving you maximum freedom in your life. You can stick with the high-paying job and start investing a truckload (or enjoying some of the perks of a large gap between income and expenses), or you can take the lower-paying and lower-stress job for other life benefits.

Debt freedom gives you life freedom. It maximizes your personal gap between income and expenses, which goes a long way toward maximizing the variety of life choices and options available to you. That’s why I’m always in favor of freedom from debt.

You've read  of  free articles. Subscribe to continue.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.

QR Code to The case for household debt freedom
Read this article in
https://www.csmonitor.com/Business/The-Simple-Dollar/2012/1127/The-case-for-household-debt-freedom
QR Code to Subscription page
Start your subscription today
https://www.csmonitor.com/subscribe