Is Debt Good or Bad? - Caleb Jones

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.

19 Comments on “Is Debt Good or Bad?

  1. Great points.

    Can I suggest that in some countries, low equity debt works. This is because certain tax laws allow you to offset the mortgage interest against your personal income.

    So for example if you borrow 95% of mortgage finance and have an interest only loan, you can claim 100% of your mortgage payments as expenses. This amount of say, $50,000 per year can be offset against your personal income tax. If you have personal tax debt of $50,000 then the example above will mean you pay zero tax.

    You wouldn’t then have principle paid down, but get cash flow and the capital gain when you sell. Not a Disney home ownership model, purely an investment donkey.

    Just an option to be considered.

    Great article appreciate your constant efforts.

     

  2. 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.

    roger that

  3. 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.

     
    Golden Words! I couldn’t agree more!

  4. o for example if you borrow 95% of mortgage finance and have an interest only loan, you can claim 100% of your mortgage payments as expenses. This amount of say, $50,000 per year can be offset against your personal income tax. If you have personal tax debt of $50,000 then the example above will mean you pay zero tax.

    You wouldn’t then have principle paid down, but get cash flow and the capital gain when you sell. Not a Disney home ownership model, purely an investment donkey.

    Yes this is often an argument I hear. Also another argument is often that if you live in your mortgage house usually the total costs are less than what you would pay as rent somewhere else therefore even if you lose the house later before you repay it you have made a profit. If you dont lose the house you got the house for free. The problem is that its very hard to get out of the obligation to keep paying and nowadays with the geopolitical climate its seems unlikely one would want to stay in the same place for so long (at least in most of the west) or even if housing will have any significant value in say 10-20 years in most western cities. I would therefore say it can be smart with these things if the house is somewhere stable and safe like some parts of Australia, East Asia, Latin America could qualify as this. I wouldn’t buy a house with mortgage in the west unless part of the agreement was that I can cancel any time with no or minimal penalty.

  5. Is it possible to negotiate better terms on a mortgage if the down payment is higher than say 50%?  I guess you own it sooner so you pay less in interest.

  6. So for example if you borrow 95% of mortgage finance and have an interest only loan, you can claim 100% of your mortgage payments as expenses. This amount of say, $50,000 per year can be offset against your personal income tax. If you have personal tax debt of $50,000 then the example above will mean you pay zero tax.

    What happens when real estate prices drop and you want to (or need to) sell the house?

    What happens when real estate prices drop and the bank calls in the loan?

    What happens if you want/need to purchase a second rental (or home for yourself) and can’t get a loan because you’re too over-leveraged?

    And on, and on, and on…

    Is it possible to negotiate better terms on a mortgage if the down payment is higher than say 50%?  I guess you own it sooner so you pay less in interest.

    More than 50%, not really.

    You also don’t have to pay mortgage insurance on down payments that are more than 20%, which saves you even more more money.

  7. What happens when real estate prices drop and you want (or need to) to sell the house?

    What happens when real estate prices drop and the bank calls in the loan?

    What happens if you want/need to purchase a second rental (or home for yourself) and can’t get a loan because you’re too over-leveraged?

    And on, and on, and on…

    Yes exactly, especially with the geopolitical situation nowadays. The chance that the real estate will have still some good values in 20-30 years, the chance you will want to stay in the same place or that it would even be safe… they are all very high risk as opposed to what it was in the past. This is what people don’t seem to realize. They are getting mortgages like as if this was the 90s or 00s but now? Anyone who has been following the news in the recent years must agree its an insane idea to commit to something like this. The world especially in the west is becoming so unstable and so uncertain so fast and the future so doubtful it should feel insane to do something like this. Yet so many have theyre heads in the sand like as if nothing happened… I really do not understand.

  8. Real estate is an interesting investment. Generally speaking we have all heard that risk and reward are correlated. The more risk the more reward should things go well for you (and the the more badly they go if you don’t.) Normally you have a fairly granular illiquid set of choices here. However, real estate is quite different. Because it is relatively easy to take equity out of a property, and level of equity is related directly to level of risk and reward, you have the ability to easily tweak your risk/reward choice almost like turning a knob. That doesn’t mean the risk reward ratio is good in real estate, that depends on a lot of factors, but it is extremely controllable in a way that is difficult in most investment classes. Of course real estate is only a low risk investment if you can spread the risk over many properties, perhaps geographically (though that has challenges). Because home expenses are very uneven (this year everything is fine, last year you needed a new roof and a new AC.) But if you have multiple units you can spread that risk making it smooth rather than quantized.

    Another thing worth thinking about in this regards with respect to the “enjoy the decline” meme is the deception of money. If you have a million dollars today that is not the same as having a million dollars in ten years, especially in a collapsing economy. The deception of money is that a dollar is a dollar. But it isn’t. Every year the government has a stealth tax on all money, it is called inflation and it is caused by over printing of money by the government. When things go really bad, this can be extremely sharp. A perfect example of this is the lie of the FDIC. The federal deposit insurance system resembles on other insurance scheme on earth. Normally when you buy insurance the insurer uses this money to buy assets which they can liquidate to pay your future claims. The FDIC basically has no such assets. Instead, what happens is that when a bank goes bust the Fed simply prints more money to cover the insured deposits. Which seems fine until you realize that in doing so they devalue all dollars, essentially instituting a stealth tax. They look to be the cavalry riding over the hill to save everyone, when in fact what they are doing is nothing short of bank robbery.

    Having said all of that, I think the predictions of decline are overblown, for this same reason. America is unlikely to suffer hyperinflation because nearly all its debts are denominated in dollars, and they control the dollars. So instead of stiffing you on your social security payment they will give you the same dollar amount, it is just that those dollars will be worth a lot less. Again, it is a horrendously evil scheme, robbing old people of money they have a right to, to make themselves look good politically.

    In most hyperinflation situations such as between the war Germany, the debt obligations were denominated in something the government didn’t control (in the case of Germany it was gold marks) so the printing of money only exploited extremely short term arbitrage causing exponential growth. America’s currency won’t collapse that fast, they will just devalue their debts, which over time will make their bonds less valuable, which will make it less possible to borrow, and that will send the whole thing down the hole. Not fast, but inexorable nonetheless.

     

  9. If you find yourself with a large amount of negative equity (stupid debt) then people should really consider the option of voluntarily declaring personal bankruptcy. Bankruptcy only lasts 3 years and leaves you with a clean slate to start again.

    The alternative is entering into involuntary indentured servitude to the banks for the rest of your life.

  10. If you find yourself with a large amount of negative equity (stupid debt) then people should really consider the option of voluntarily declaring personal bankruptcy. Bankruptcy only lasts 3 years and leaves you with a clean slate to start again.

    It is not that simple. You can’t just decide to be bankrupt. They will first claim and confiscate all your assets and monitor all your accounts and activities very closely. Only if it is not possible to cover the debt with all your total assets then you be declared bankrupt. This means you will have absolutely nothing or would have to break the law and hide some stuff, which is basically stealing, regardless of whether you get caught or not. Alternative option is to donate stuff to friend/family but that is a grey zone and could also lead to problems. If you really don’t have anything indeed it is a good option. But I would not do that if I did have savings / valuable or needed assets etc. You also need to save something for emergencies otherwise you will get out of debt and then be found borrowing again, which is even more stupid.

  11. @Ramphastos says

    If you find yourself with a large amount of negative equity (stupid debt) then people should really consider the option of voluntarily declaring personal bankruptcy. Bankruptcy only lasts 3 years and leaves you with a clean slate to start again.

    Let’ just be clear about this. Bankruptcy is a form of legalized theft where, because of your supposedly destitute situation, you can tell all the people who your agreed to pay that they can go pound sand. There are situations when there are no alternatives. But let’s just be clear that it is legalized theft.

    The alternative is entering into involuntary indentured servitude to the banks for the rest of your life.

    No, the alternative is either only taking on debts that you can pay back or working hard to make money and fulfill your obligations. Like I say, there are situations where bankruptcy is certainly understandable (for example, overwhelming medical bills which is one of the primary causes of bankruptcy in the USA), but it is still stealing, and although it might get wiped off your credit report in a few years that sort of thing stains you as a man far longer than a few years.

    Using bankruptcy as a financial strategy rather than an action of last resort for the utterly destitute is a moral as well as a financial bankruptcy.

     

     

  12. Let’s say you own your house. Would it be a good idea to sell it, invest the money somewhere safe, and just rent forever? (Assuming you generate enough monthly income and got zero debt).

  13. Let’s say you own your house. Would it be a good idea to sell it, invest the money somewhere safe, and just rent forever? (Assuming you generate enough monthly income and got zero debt).

    There are several answers depending on your scenarios and goals:

    1. If you’re settled where you want to be for 10+ years, pay off your mortgage and just live in it mortgage payment-free forever.

    2. If you’re not settled, sell it and take the equity and purchase cash-flow rentals (making sure to stay below 50% loan-to-value), then rent a place for yourself to live in.

    3. If doing five flags, sell it and take the equity and purchase a rental cash (100% paid for) then rent a house/apt in your Country A but use the rent from your rental to pay your personal rent every month.

  14. Caleb, how do you plan to rent with 5 flags? Will you rent the place for a whole year even when you are not there? Always search for a new place? Or try to subrent for when not there? Obviously the first is most convenient but depending on the rent costs and your income it could be a significant waste. Also does renting for a whole year even if not there affect your residence status?

  15. Caleb, how do you plan to rent with 5 flags? Will you rent the place for a whole year even when you are not there?

    For my primary home, yes. For the other two countries, I will use airbnb and similar.

    Or try to subrent for when not there?

    No. Normally I would do that, but I want my main home to truly feel like my home. Yes, I’ll be wasting up to 6 months of rent a year, and that really sucks, but I’ve already budgeted for that.

    does renting for a whole year even if not there affect your residence status?

    No. Has nothing to do with it.

  16. It is not that simple. You can’t just decide to be bankrupt. They will first claim and confiscate all your assets and monitor all your accounts and activities very closely. Only if it is not possible to cover the debt with all your total assets then you be declared bankrupt. If you really don’t have anything indeed it is a good option.

    I’ve always wondered if it was an option for me. I owe a whole bunch of money in student loans and a credit card but that’s about it. The only asset I have is my car and I bought it with cash waaaaaay back in the day. I don’t mind just paying the student loans down since I don’t own any other real assets and don’t intend to because I want to be a digital nomad.

  17. Only habe the mortgage.  It’s 45% of the value of the condo.  That’s it.  Car loans taken care of long ago.

  18. I have some debt, both good and bad, but it isn’t what is ruining me. I am being gutted by f@cking medical expenses.

    I used to think once I had payed off my mortgage I’d be free. Ha!

    Guys, be careful, particularly if you have dependents. Medical costs will get you by the balls!

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