More on the debt-free fallacy …

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Recently, I wrote a post that (I hope!) exploded the popular view peddled by the Ramsey/Orman/Frugal crowd: that you should pay down all debt, including your home loan. You will need to read that post to see why it’s such a bad idea.

As expected, the post generated a lot of reader comment, much centered on the theme that owning your own home outright is (a) better than doing nothing (true, but eating pizza every day is also – marginally – better than eating nothing) and (b) a great emotional ‘cushion’.

Money Monk summarized it perhaps most succinctly:

I think it all depends on a person risk tolerance. Some people just love the security of a paid for home. I just think either way is OK. I just would not suggest someone scraping by just to pay off their mortgage. Forcing themselves to live frugally

Either way is definitely not OK:

Sure, either way is better than NO way …

…. but, one way is clearly better than the other way!

The ‘catch 22′ here is that the very thing that these people THINK will make them secure (e.g. paying off their home loan) actually makes them much less so, in the long-term.

That doesn’t mean that you shouldn’t make emotionally-self-satisfying decisions … for example, owning your own home is not always a smart FINANCIAL decision, yet it’s one that I actively encourage people to make for exactly the EMOTIONAL reasons that Money Monk (and others) stated:

But, that does NOT mean that you should own the property outright …

… there is far more REAL SECURITY in knowing that you will retire with enough to live off than there is in the FALSE SECURITY of having ‘just’ $1 Mill net worth in, say, 20 years (usually wrapped up in your home ownership):

But, I’m not out to change EVERYBODY’s view … only SOME people’s: those who want to become Rich(er) Quick(er) ;)

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13 thoughts on “More on the debt-free fallacy …

  1. I remember that post. People have an obsession with the idea of being debt free. They don’t seem to understand that thanks to tax laws and other reasons some debt is fine to hold (mortgage and student loans come to mind). And depending on the market it makes much more sense to pay the minimums on these good debts while you build investments that have higher rates of return.

    For example:

    You have an extra $1,000 each month
    Your Mortgage is $1,000/month at 5% interest
    You can get a return of 8% with a potential investment

    Which do you do- overpay your mortgage or pursue the investment? D’uh! You make 3% more pursuing the investment AND preserve your tax deduction in the mortgage interest.

  2. This post makes it more clear, AJ. Anyone thinking to get out from under a mortgage today – by either selling or renting – will be able to see it quicker perhaps than those who are not looking at the house that way.

    Of course, there are those who will say that you can take out a HELOC or refinance, but they also would “sweat” their ability to pay off the mortgage should they lose their income.

    Friends of mine who worked in the mortgage industry were telling me a few years ago that MANY people do not know that you can simply call up your bank/mortgage company and talk to them (otherwise called “negotiate”) about your need to delay payments or something. The banks do NOT want to own your property – they would end up selling it for less, and lose the interest they had already negotiated. By working out a deal with you that helps you eventually pay off the mortgage, the bank/mortgage company ends up better.

    I had asked because I came across someone who walked away from the house and the mortgage – just walked away, leaving furniture – and that was such an unheard of behavior for me that I raised it with a friend in the mortgage industry.

    Cash in a house is one of the hardest to get back, despite the HELOC. What if I wanted to travel and have no house?

    Now, if I could rent the house….then we’re talking real estate investment, and the best money to use (hasn’t it always been said) is OPM – Other People’s Money (in this case, the bank’s).

  3. @ totaltransformation – D’uh indeed! Thanks for a great summary!

    @ Diane – Your friends may have been in severe ‘negative equity’ territory. Interestingly, simply paying off their mortgage to provide phantom equity would look good on paper, but doesn’t solve their underlying problem.

  4. 7mil,

    to each their own. In my parents case it was wise for them to pay off their mortgage because they have no knowlege of stocks and investments.

    In my case it maybe be wise. Some people just like the simple no risk life. Younger people tend to take more risk because time is on their side.

    Unless more people are educated about the market, many will go the debt free route because it take no risk

  5. @ MoneyMonk – To each their own, indeed. Doesn’t make it right, though … stand by for more because you raise an important point!

  6. You don’t make 3% Totaltransform…..remember a thing called taxes?!?!?! Plus if you are only making 8% on your investment then you are in the wrong vehicle.

  7. I happened to stumble on this site doing some research on debt free. No wonder I’ve never heard of this site or even the radio show apparently associated with it. Anyone who thinks that living debt free is the wrong thing to do needs to have their head examined. That’s like saying Ohh we shouldnt live debt free we’re on the planet to make banks rich on our hard earned money. Nice mentality you got there. It just doesn’t hold any water. The question you should be asking yourself is would you rather live be constantly paying out your hard earned cash to banks making money off you not paying for your own assets or should you own your assets outright and control a greater portion of your hard earned cash? The choice IS obvious.

  8. @ Mike – Is the objective to avoid paying the banks money or to reach your own financial goals? If you can do that without paying the banks any money, more power to you …

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  10. I think the key concept here is good vs. bad debt. Unsecured debt, with interest rates of 15-30% is very bad debt! Home mortgages and student loans are good debt. If people pay off the credit card debt, and keep the mortgage so they have more cash for investments, they are growing their financial tree so to speak. That is, if they take the time to get a financial education and know what to invest in, how to make compound interest work for them, etc. The first step is learning How Credit Works, then using it wisely.

  11. Hello everyone! My assistant Linda commented here in November (above), and I’m just seeing this… So I wanted to add my two cents since there’s a link to my website posted here.

    @totaltransformation – Risking $1,000 a month on a possible 8% return instead of a guaranteed after-tax ROI of 5% by paying down mortgage debt is NOT such a “Duh” decision. If you do get 8% you must pay taxes, and if you live in a state like CA, then after taxes you’re about even. Plus you have slippage… transactional fees etc for the investment / trade. So risking your $1,000 a month on 8% instead of a guaranteed after tax return of 5% is not always so smart, and a bad example.

    People with double-digit interest rates on credit card debt, especially the many folks paying 20-30%+ interest, are not likely to find a better investment opportunity in their entire life than inside their own liability column. Every dollar in debt paid off is a guaranteed after tax ROI of 20-30%. Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time. What makes you think someone in debt could pull off such a stunt?

    I think Dave Ramsey provides sound advice for most people, and while I think it’s better to expand your means and increase your income instead of living like a popper, his advice has proven to help many hundreds of thousands of people to stop paying interest and start earning interest, and that’s the key.

    If you’re carrying debt and it buys you an asset that truly pays the interest for you when you account for taxes and expenses, then no one can argue with your financial intelligence. Good debt can make you wealthy. Look at Donald Trump!

    But if you are paying interest on debt and it’s even questionable that you’re money is doing better somewhere else instead of paying off the debt, then you’re probably only fooling yourself.

    BTW – I have made my living in the stock market trading stocks and options. In fact, I’ve made more money doing that than anything else, but I also know I am a RARE bird. 95% of the people who go into the market get their head chopped off and lose, period. If you are messing around thinking you will get rich fast, then I wish you luck and offer one solid piece of advice: BUY, STUDY & IMPLEMENT the book “Trading for a Living” by Dr. Alexander Elder. The man is a great teacher (I trained under him myself) and the book is priceless. Forget about buying all the fancy trainings, seminar, videos etc, and just buy the book for $20. After spending over $50k on my own training, I can say the most important lessons are inside that one single book. Best wishes!

    Last but not least, if you’re guilty of carrying high interest credit card debt, then be a smart investor and invest for the highest, most probable ROI: In your balance sheet, on the right side… and Get Out of Debt FAST! [link removed]

    STOP Paying Interest & START Earning Interest ASAP!

  12. @ Jesse – Interesting move: from trading to helping people get out of debt. Good luck with it.

    Thanks for your comments, as well 🙂

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