The Demons of Debt

Over the last twenty years, consumer credit has grown at an astounding pace. The chart above shows the cumulative growth in consumer credit (excluding mortgage debt) compared to the growth in personal disposable income (income after taxes). The rate of growth in consumer credit has outpaced the rate of growth in income by about one third. Credit allows us to have the things we want and need today, but only at a significantly higher cost and at the price of our financial security.

The average rate on credit card debt is currently 15.07% according to So for every one hundred dollars spent on the credit card, and not paid off within a year, your purchases cost you an extra $15.07. According to Federal Reserve statistics, of those households carrying a credit card balance, the average outstanding debt is $15,706. That means these households pay an extra $2,366 per year in interest alone. They pay the equivalent of the balance in interest every six and a half years!

The current interest rate on Stafford Student Loans is 4.29%. More students than ever, 71% in 2015, are taking out loans for their undergraduate degrees. The average undergraduate who took out a loan left school in 2015 with over $35,000 in debt to repay. These students will pay another $17,195 in interest over a twenty year loan term.

Debt also increases your monthly fixed expenses. You don’t get to choose whether or not to pay your debt payments. Over time, these debt payments actually reduce your ability to buy things, and definitely reduce your ability to save, as they eat into your paycheck. And what if you don’t get a few paychecks because you’ve lost your job or are sick or injured? Debt can very quickly get you into a very difficult situation, where all that you have is in jeopardy.

Jeff and I live debt free. Completely debt free. We were able to even pay off our mortgage a few years ago. Yes we do use credit cards, but we use them for convenience and pay them off each month. No fees, no interest. We have purchased all of our cars for cash over the last twenty years. This has provided incredible financial freedom. I can’t begin to tell you how good it felt to not have to worry about whether one or both of us lost our jobs during the Financial Crisis of 2008 and 2009 when so many others were losing theirs. If the worst happened, we could easily scale back our spending, because we didn’t have any fixed monthly debt expenses. One of the reasons we were able to retire so early was because we do not have a mortgage payment. All of that interest saved was actually saved, helping us to grow our nest egg.

If you have debt, get rid of it. It will sap your finances and keep you tied to your job regardless of whether you are happy. Here are a few tips for reducing debt.

  1. STOP BUYING THINGS ON CREDIT! This will give you a fixed target to work on.
  2. Build your emergency fund up. This will reduce the need to put unexpected expenses on credit cards.
  3. Target one debt item at a time. The highest interest rate loan, makes most economic sense, but some experts suggest paying off the smallest balance loan first. You’ll get a pyschological boost from your accomplishment. Just pick one and start paying it off. Once that is paid off, commit the same payment you just got rid of to reducing the next debt item, repeating until all that is left is your mortgage. Then start adding to your mortgage payment. Every extra dollar you pay goes toward reducing your principle.
  4. Yes, contribute to your 401(k), at least enough to get your employer match. There is no point in giving up free money.

Reducing debt is the same as increasing savings. In the case of credit cards you get a very juicy guaranteed rate of return of 14.95% on every dollar paid down. Even today’s low mortgage rates, at 3.80% for a traditional thirty year loan, are worth paying down. There is no other investment option paying a guaranteed rate of return that high. Every dollar of debt taken on is a step toward the financial precipice, and every dollar of debt eliminated is additional financial security and a step toward financial independence.

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