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This is the twelfth day in our 31-Day Money Challenge. Over 31 days we’ll publish 31 podcasts, each designed to help you move closer to financial freedom. Yesterday we had Maxine Sweet from Experian on the show to talk about improving your credit. In today’s podcast, we start a 3-day series on getting out of debt.

Sponsors: The 31-Day Money Podcast is sponsored by Betterment and Personal CapitalBetterment and Personal Capital are two tools I use to make investing easier, less expensive, and more effective.

Topics Covered

  • What is good debt and bad debt
  • What are some examples of good debt and bad debt, and why should we care about classifying debt
  • Why car loans should be avoided
  • How borrowing causes you to spend more and limits your choices
  • The 4 rules of getting out of debt
  • The getting out of debt plan


Transcript of Podcast

Hey everybody. Welcome to day 12 of the 31-Day Money Challenge. Today we’re going to be turning to a new and critical topic, debt. Credit card debt, mortgages, school loans, car loans, boat loans— all of that. What I’ve decided to do is cover debt over a three day period. Today we’re going to look at the problems of debt. Good debt versus bad debt, if there is such a thing.

We’re going to compare different types of debt and the impact they can have on your finances. And we’re going to finish up with my approach is to getting out of debt— what my wife and I basically did to eliminate about $200,000 of debt over a number of years. It’s a very straight-forward approach that I’m going to share with you. That’s what we’re going to do today.

Tomorrow we’re going to focus exclusively on what’s called the ‘debt snowball’. I think most people are familiar with it, but if you’re not, it’s simply a way to climb out of debt faster than just making the minimum payments each month. As part of that, we’re also going to look at the tricky question of which debts you should pay first. Do you pay the smallest loans first or the ones with the lowest interest rate? If you have some extra money to put towards your debt, where should it go? We’re going to tackle that topic tomorrow.

On the third day of this mini-debt series, we’ve got a podcast I call, ‘Which way is up?’ which relates to debt and other things as well. There are competing and, sometimes, conflicting financial goals. For example, for an emergency fund, we may want to get out of debt. We may want to maximize our retirement savings. These goals can compete with each other and I get a ton of questions asking “what should I do first? Should I save for an emergency fund before I pay off my debt? Should I pay off my credit cards before I save for retirement? What about a child’s education? Shouldn’t I start when they’re young? What if I still have other debt?” In the third day, we are going to talk about those various questions and I will give you my thoughts on how you can best answer them for your specific financial circumstance.

It is an important question. In some cases, you may have a number of options and, frankly, going one way versus another, paying off your debt first and then saving for your retirement. Or, maybe, doing a little of both at the same time. They are pretty equal. You could probably do one or the other and it wouldn’t have a big impact one way or another. However, in some cases, the answer to that question of how you prioritize your financial goals, between debt and saving, can have a significant impact on your finances.

Unlike some, I don’t believe it is one size fits all. It is fine to follow whatever, some 10 step program, but if you do it blindly, you could be hurting yourself. It is important to understand the reasons behind different approaches that people recommend. I don’t try to force an approach on anybody but give you things to think about so you can make an intelligent, rational, and reasonable choice for your specific circumstances. That’s what we are going to do over the next three days.

With that, let’s go into the main topic for today: debt. We are going to cover five things in this episode, about debt.

The first is good debt versus bad debt. What in the world are people talking about? Is there such a thing? To me, the answer is yes. Some debt is less harmful than others. What is good debt and what is bad debt? To me, good debt is debt that you use to buy an asset that goes up in value and/or generates income. Bad debt is everything else. That isn’t the only consideration. For example, you can have too much good debt. Just because I classify something as good debt doesn’t mean that I think I should take it on. Or, it doesn’t mean if someone came to me and asked me about a specific circumstance that I would think it’s debt that they should take on. However, I think there is some debt that is reasonable and can help you build your wealth. Most of the debt consumers have, though, I think, falls into the bad debt category. I think the real question is how does classifying good debt and bad debt help us make good financial decisions?

That brings me to point number two. I want to look at some examples. The first one is a mortgage. A mortgage is generally considered good debt because you are buying an asset that in the long term will go up in value, despite the real estate crash that we have lived through over the last few years. Over the long time, real estate goes up in value, typically, at the rate of inflation over a long time. Certainly, in certain markets, you can have bubbles and real estate can go up or down, significantly. When you spread that out over many years and many markets in the US, it goes up by the rate of inflation.

In that sense, a mortgage is good debt. However, I think you can take on a bigger mortgage than you should. We’ve certainly seen examples of that. The other thing that mortgages can cause you to do is to spend more on a home than you should. I’m going to have an entire episode on mortgages, including how I think you should look at mortgages in terms of how much you can borrow, how much you’ll qualify for, and also how much you should borrow. I’ll even talk about that in a few minutes, in this podcast. I generally put mortgages in the good debt category as long as you aren’t overspending for a home and not stretching your budget, too much. I also put debt for rental property investments in the good debt category.

Now, again, folks can stretch themselves too thin. If you have listened at all, today, Ramsey’s story of going into the real estate business—I think he was completely leveraged, probably to a degree that majority of people would never go. He, from what I understand, was in a very extreme circumstance. Think of good debt as dessert. Yes, it’s good, but too much of it is a bad thing. You have to be very careful about how much debt you take on. In my case, I own, with a business partner, four rental properties. We are very cautious about how much we borrow. We have ample reserves. Frankly, we could have all four properties without a tenant and we would have no problem paying the mortgages. It is a very safe investment, but it does involve some leverage. It does involve some debt, but its generating income for me both in the form of rental income and appreciation over the long term of the properties. That is the second example that I would put in the good debt category.

Car loans I would put in the category of bad debt. I wouldn’t put it in the category of the worst debt, which we’ll come to in a minute, but, for me, the goal should be pay cash for a car. When my wife and I got married, we had a car. It wasn’t worth a whole lot. It was a used car, but it was paid for. We bought our first car when we adopted our children, in 1995. We borrowed the money for it. It was a Plymouth Grand Voyager. It was sweet. It was the first minivan, that I was aware of anyways, that had the sliding doors on both sides. We take that for granted, now, but I’m old enough to remember minivans that had only had sliding doors on one side.

When we adopted both our children at the same time, it was perfect. I can put one in the backseat on one side of the van and our other child in the other side. Anyway, we borrowed for the car. Was it the end of the world? No. Did it wreck our finances? No, but as I learned more about personal finances and how to manage money, I came to the conclusion that, generally, you shouldn’t borrow to buy a car. You should buy what you can, for cash. That’s what we’ve done for our last two vehicles. We replaced the first minivan with another one in 2005, nine years ago, and we still have it. We paid cash for that van. Then, a couple years ago I bought a used Camry. We paid with cash for the Camry.

I don’t classify car loans as the worst kind of debt. Why? You are getting an asset, but it is depreciating. It certainly is not an investment. I think many people who find themselves with a car loan could, if they wanted to, sell the car and pay off the loan. I understand, in some cases, the car isn’t worth the amount you’ve borrowed. Part of that is how quickly the car depreciates and how much of a down payment you made but there is an asset backing that debt. For me, the whole thing with good versus bad debt is a bit of a sliding scale. I wouldn’t classify car loans as the worst kind of debt you can get into but I do think it is a problem. I’ll get into that in a minute.

The fourth kind of loan a lot of people have and I want to mention— I’ve got five here, total—is school loans. School loans are an interesting topic. Education is, rightly so, a valued commodity. About 30 percent of the population has a college degree. That is up significantly from a couple of generations ago. The job market is hard enough, as it is, and a college education can help you in a lot of ways. Here’s the problem. A lot of folks are getting degrees that, frankly, from a workforce perspective, aren’t very valuable. It’s not to say that the topics they are studying aren’t important. Particularly with a general liberal arts degree, it’s not going to help you very much to get a significantly better job. It may be a great thing to study and it might be a passion for someone, whatever it is. Art history and the list could go on and on. I was an English major so I got a liberal arts degree, although I planned to go to law school.

You have to question the value of these kinds of degrees. That’s true whether you borrow to go to college, or not. When I’ve talked to our children about college education, where they want to go to school, and what they want to study, I always asked them what the end game is and why they are doing this. What are you going to do when you graduate? Don’t just assume a college degree is valuable. Not all college degrees are of the same value. It is a question that I don’t think a lot of college aged students are asking. It’s this feeling like “I’ll just get a college degree and I’ll be able to find a job” but it doesn’t work that way, anymore. It is important to understand what your goal is with your degree. The other thing is that the cost of college education has continued to sky rocket. It’s settled in, a little, over the last year or two.

However, since I’ve graduated, the costs of education has really sky rocketed. Today, it isn’t unusual for someone to graduate with tens of thousands of dollars in school loans. In some cases, it’s six figures. When you saddle yourself with that kind of debt, it can have an impact on your life for decades. It really can have a serious impact on your options and your finances for a very long time. In my case, I graduated from law school with about $55,000 in debt. This was more than 20 years ago, so I would say, in today’s dollars, it’s probably low six figures, in debt. It took my wife and I 16 or 18 years to pay off. It took us a long time and I was practicing law. You can imagine getting a liberal arts degree and having $100,000 in debt. It’s going to have an impact on your life for a long time.

The thing that I stress when talking to our children and other folks of that same age, is to do everything you can not to go into debt. Many people that do, work two or three jobs. I know it doesn’t seem like fun. You want to go to college and have fun and learn, but you’re going to pay a price for it, eventually. Folks go and work during college. Also, think about the schools that you are attending. In Virginia, for example, you can go to a two year school and get your two year degree. If you get a good enough GPA, you get automatic admission into other four year colleges to finish your degree, including some great schools: William and Mary, Virginia Tech, UVA.

The cost is, relative to a lot of the private schools, very small. It’s not insignificant, but if you combine that sort of approach to college education along with working hard, you can graduate with a degree and little to no debt. I’ve interviewed folks on this podcast who talk about going through college without debt. It is certainly doable. Again, school loans are not the worst kind of debt, particularly if you get a degree that you can use to land a good job, but they’re still questionable enough that you should do everything you can to avoid them.

This brings me to the fifth kind of debt. I think it is the absolute worst and should be avoided at all costs. This is credit card and other consumer debt. This is the kind of debt that you rack up and don’t have anything to show for it. You may have memories. You go on vacation or out to eat. You buy clothes that, after you buy them, are worth pennies on the dollar. You rack up credit card debt and all you are really doing is mortgaging your future with this debt. Of course, you add to that the high interest rate on credit cards and it can easily spin out of control. I was thinking the other day, “what’s the most popular personal finance book, right now?”

If you go to Amazon and look it up, it’s Dave Ramsey’s “The Total Money Makeover”. Who is reading this book? It’s people who don’t have any savings. His first step is to save a thousand dollars. It’s folks that don’t have any savings and folks who have a lot of debt. He’s helped a lot of people. If you’re in that situation, I think his book is a good one to read. Part of me thinks “how do we help people to avoid getting into this problem in the first place?” If you’re in good financial shape or you are young and just starting out, your goal should be to never have to read Dave Ramsey’s “The Total Money Makeover”. That should be your goal. You don’t want to ever have to read that book. You don’t want to put yourself in that situation to begin with and credit card debt will put you there faster than anything. Okay, I’ve said enough about credit cards. By the way, I’ve said in the past how my wife and I charge almost everything to our rewards credit card. If you think doing that will get you into trouble with credit cards, don’t do it. Just don’t do it. It isn’t worth the risk.

I want to move to the third topic of today, out of five. What’s the problem with all of this debt? On one level, it is kind of obvious. You end up with this debt that you have to pay off in the future. However, before we get to that, borrowing generally causes us to spend more than we should. I’ve found that to be true. I paid cash for my last car. I remember, at the time, thinking that I could afford to get a loan. It sort of hurt to take money out of my savings. I was looking at different cars, including some that were more expensive than the used Camry that I bought, but I realized I needed to pay cash because it will hurt to take money out of the bank and it should hurt.

If I borrow it won’t hurt as much, but it’s not because I’m not spending the money. I’m just tricking myself into thinking it doesn’t hurt because it’s just a payment each month. It’s much smaller than paying cash. Borrowing to buy something causes us to spend more than we should. It gives us comfort in what we are doing and we shouldn’t have that comfort. It should be uncomfortable when we are spending that kind of money. Obviously, most people can’t pay cash for a home. I understand that, but for cars and month to month spending, it should be cash. Borrowing causes us to spend more than we otherwise would. The second problem with debt is that we are spending our future. We are taking away options for ourselves. One of the great things about being out of debt, for us—we have our mortgage but that’s it—is the options that it has in terms of what both of us do for a living. She stayed at home with our children and now she works part time at an adoption agency. It’s a charitable organization. She’s an adoption counselor.

With that, let’s go to the fourth of the five topics. These are my rules of debt. You’ve probably already figured this out, but these are the rules that we live by, now. We haven’t always lived by them. I don’t want you to get the impression that we have always had this thing figured out. We haven’t. We’ve had credit card debt, car loans, school debt. We’ve have, basically, all the things that I am talking about. Now, here are the rules I live by. Mortgages are good debt.

However, I found that if you can keep your payments under 20 percent of your gross income, and ideally under 15 percent, it is much more comfortable. When you get above 20 percent for your monthly mortgage payment, particularly if you have other debt, things can get very uncomfortable. You need to work hard to keep your payments under 20 percent, preferably under 15 percent. You can qualify with a higher ratio— Again, we’ll talk about that when we get to mortgages later this month. Having owned two homes, now, we first started out with a payment that was more than 20 percent of my gross income. Today, it is much lower and it is much more comfortable. Two, never borrow for a car. You’ve probably figured that one out. That forces you to make sacrifices. Maybe, you have to buy a car that isn’t as nice as you’d like. Down the road, you will be thankful that you did. You’ll realize that cars are just not that important.

When it comes to quality of life, for me, anyways, driving a car that grabs people’s attention when I go down the road isn’t important. It’s just not worth going into debt for. Number three, never let your credit card debt carry over into the next month. If you do use cards, pay them off in full every single month or don’t use them. Number four, I know this is a bit controversial but these are the rules that we try to live by with our children, is never borrow to go to school. Again, I know that is hard for some folks. I know some parents help their children, some don’t, but I’ve talked to enough people that I think that most people can get through a reasonably priced, good college without borrowing. Those are my rules of debt.

That brings me to the fifth and final topic: the get out of debt plan. At one level, getting out of debt is easy. Just pay off your debt and don’t go into more debt. Eventually, you’ll be debt free. It really is as simple as that. I think about it in four steps. The first step, which is most important, is stop going into more debt. If you do stop, you’ll eventually be debt free. There’s ways to shorten the process and make it less painful, which I’ll talk about in a minute, but you’ve got to stop going into more debt. You have to get radical about it, even if it means cutting up your credit cards, not taking them, not using them, buying a car that isn’t the nicest on your street, or whatever. You just have to stop going into more debt. Make that pact. I know, from experience, it’s not easy. Going into debt is an easy thing. “It’s just a little bit of debt. The payments won’t be that bad. The furniture looks nice.” If you want to get out of debt you have to stop going into it. Some of that is planning. We’ve talked about budgeting in earlier episodes of the 31-Day Money Challenge. For example, save for a new car years before you actually need it. I think, more than anything else, it’s just a decision. You’ve got to stick to it, no matter what. I’m not suggesting this is some earth shattering principle. It’s not. It’s basic, but you have to stop going into more debt.

Step two is something we did to eliminate debt. What I mean is that you may have some debt that you can get rid of immediately. We did. I had a loan on a car that we just didn’t need. I sold the car. I loved that Acura. It was a great car and I miss it but I wanted to get rid of the debt. That was more important to me than keeping the car. Obviously, you can’t get rid of all debt like this but you can make some tough decisions. Some people sell their house and move. That’s obviously more extreme and more disruptive to your family. There are costs associated with moving. I’m not suggesting it is right for everybody, but it’s the kind of choice you can consider. Selling a car is much easier. Look at your debt for things you can eliminate. Do you need that car? If you’re reading along on the blog, you know that Abby Hayes, who writes for doughroller.net— we’ve just started a series and we published a post she wrote about her husband and her getting out of debt. That’s their goal. It will take longer than a year but it’s their goal to make great strides in 2014. One of the things they are going to do is sell their car. That’s part of their plan.

The third step is to refinance all of the debt that you can. Look at all of your debt to see if you can lower the interest rate, whether it is refinancing a mortgage, refinancing a home equity line, transferring credit card debt over to a zero percent card, or refinancing a car. One thing that we did was use a home equity line of credit that had a very low interest rate. We transferred some high interest rate debt to that low interest home equity line. That’s risky because that line is backed by your home. If you don’t pay it, you could lose your home. I don’t recommend that for everyone. You have to make that choice for yourself. The key is to get the interest rate on your debt as low as you possibly can and that may take some time. Maybe, it can’t all happen at once. You may need to increase your credit score before you can qualify for a lower mortgage rate or a zero percent credit card. That’s why we talked about credit scores over the past two days and why they are so important. This may be a longer term process for you. It doesn’t always happen quickly. Getting your interest rates as low as possible will result in you paying less interest. It will get you out of debt faster. When we get to the third day in this debt series, we’re going to talk about which way is up, what you do first, and debt versus emergency fund versus saving for retirement. Having low interest rates on your debt gives you a lot more flexibility when it comes to how you can tackle all of those competing goals. There are a lot of good reasons to get the interest rate on your debt lower.

The fourth step is what we are going to talk about tomorrow. This is the debt snowball. It’s really the primary way to tackle your debt but we’ll get into it tomorrow. You may have also heard of the debt avalanche. Sometimes, I think these terms are a bit of overkill, but we’ll talk about all of that in tomorrow’s show. It is basically the same process my wife and I used. That’s what we will cover tomorrow. That’s it for today’s episode. I hope you join us again, tomorrow, because the debt snowball is an important thing to understand. We’re going to look at some related concepts, too. For example, the difference between paying the minimum payment on your credit card versus paying extra and the difference in how long it will take you to get out of debt and how much you’ll pay. It’s just eye popping and startling that it can make such a big difference in how long it will take you to get out of credit card debt if you make the minimum payment. It’s really something. We will look at that tomorrow.

That brings the show to a close. I hope you found this episode helpful as the first of three on getting out of debt. As always, you can find the show notes to this episode at doughroller.net/podcast19. Feel free to email me at [email protected] I love to get your questions and comments. You can also leave a voicemail with a question or comment. Just go to speakpipe.com/doughroller. If you haven’t already, please subscribe to the podcast. Go to doughroller.net/itunes and it’ll redirect you to the iTunes page where this podcast resides. You can subscribe and leave a review. I love to see the reviews, the good and the bad. They make the show better. Lastly, if you haven’t already, you can sign up for our newsletter at doughroller.net/newsletter. It goes out every Saturday and is packed full of resources and tips to help you make the most of your money. Until next time, remember, the best thing money can buy is financial freedom.

Day 13: The Debt Snowball

Author Bio

Total Articles: 1081
Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Article comments

Art Copeland says:

Rob, hey, I am really enjoying the podcast series, and appreciate all the time & effort you are putting into these. For the listner question about pulling from retirement accounts early, I was wondering about IRS Rule 72t and if that was applicable here? Thanks! Art.

Rob Berger says:

Art, you are absolutely right! Great point. I put that out of my mind for some reason in answering his question. For others, here’s a link to the IRS page with additional info on 72t–http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments

Md. Taslimuzzaman Fakir says:

Rob, hey, i appreciate all the time & effort you are putting into these. Please help me.

Natalie says:

Thank you for including a transcription of the recording! I always think to myself that I will listen to podcasts later, but I never do. I’m more of a visual/reading learner, so it’s been a little disappointing that most of the content of the 31 day series has been podcasts. I do read what there is to read and go to the links you post, and it has been interesting and helpful, so I’m still following along 🙂