Is Debt Good or Bad?
One of the strongest aspects of my financial advice is to pay off all of your debts (except possibly your mortgage payment if you have one) and stay debt free for the rest of your life.
This advice is a solid foundation of Alpha Male 2.0 and will always be so.
This is because debt is the number two killer of men in the modern era (number one being oneitis). Excessive debt can and will destroy your financial life and overall peace of mind for decades. You will indeed be a slave to the lender and you will never, ever be free if you have serious debt in your life. You will constantly have to worry about being late on your debt payments, having your lenders harass you, screw up your credit, sue you, and so on. You will also have much higher minimum monthly income requirements because you’ll have to make payments on all of your damn debt in addition to your lifestyle. Not to mention the massive opportunity cost of sinking all of your money into your stupid debt instead of putting it somewhere where it will create long-term happiness, such as savings, investments, and your lifestyle.
There is a counter-argument that says that debt is great because it provides financial leverage that isn’t possible without debt.
Is that true? Let’s examine.
The Two Kinds of Debt
There are two distinct types of debt: stupid debt and smart debt.
I have a very specific and narrow definition for smart debt. Smart debt is when you have a loan backed by an income-producing, appreciating asset with a high amount of equity.
“Income-producing” means that the asset actually creates positive cash flow per month for you. If you have a rental property with a mortgage, and every month the grand total expenses of that property (mortgage, upkeep, taxes, vacancies, management fees, and so on) are less than the monthly rent you receive, that means you get some real net income every month. That’s income-producing. If instead you have to actually pull money out of your checking account every month to “feed” that property because the rent isn’t enough to pay those expenses, that is not income-producing, and your mortgage is now classified as stupid debt.
“Appreciating asset” means that the thing that backs your loan is something that goes up in value most years. A house would qualify as this, but something like a boat, car, or college loan would not. Those things are worth less every year. Having debt backed by a depreciating asset (like a car) is insane in the extreme. This is stupid debt.
“High amount of equity” means that the loan on the asset is only about 50% or less of the total market value of the asset. If you own a house worth $200,000, and your mortgage is $195,000, that means your equity is $5,000. That’s totally insane. You’re going to get wiped out by the next real estate crash and be in deep shit. If you ever have financial trouble, or need to move, you’re going to actually have to spend money in order to sell your house (realtor costs, closing costs, etc) since you have virtually no equity. Thus, your mortgage on this house is stupid debt.
If, on the other hand, you have a $200,000 house and your mortgage is $100,000, now you’re in very good shape. You can move any time you want, even if you have to reduce the price of the house to do so. If a real estate crash comes, you barely care. Even if your value goes from $200,000 to $170,000, so what? You only owe $100,000. No problem. This is smart debt.
So if you have debt, but the loan is backed by an income-producing, appreciating asset with a high amount of equity, it’s smart debt (or at least usually is). Any other type of debt is stupid debt.
(Note: There are bizarre 2% Rule exceptions to everything I’m saying, and I’m sure someone will use these to make their points in the comments. As always, the exceptions prove the rule.)
Therefore, stupid debt includes things like:
- Credit cards you don’t pay off 100% every month
- Student loans
- Car loans
- Personal loans
- Loans on other guy-toys like boats, motorcycles, etc
- Real estate with low equity
- Real estate that doesn’t generate positive monthly cash flow
- Medical debt
- And so on.
You should have ZERO stupid debt. ZERO. I have zero. I will always have zero. You have no idea how good it feels to have zero debt. Man, it feels good.
Smart debt is okay provided it meets all the criteria I listed above. I have some smart debt and will soon acquire more. But since I follow my own advice, this debt will only be debt that is backed by income-producing, appreciating assets with a high amount of equity. You’re not going to see me put 5% or 10% down on some rental property that I’m not sure will create cash flow. That’s stupid. Instead I’ll put 50% down on properties I know for a fact spin off money every month (by carefully studying the numbers before I purchase).
Do not have any stupid debt. If you have any, your number one financial goal should be to pay this debt down to zero as fast as humanly possible.
You will never be a free man until you do this.