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Responsible borrowing--how to use debt to improve your finances
As much good as he does, Dave Ramsey drives me nuts with his views on debt. Dave Ramsey, as he readily admits, did some really stupid things with debt. Leveraged to the hilt on bad real estate deals, he went bust in a way most of us could never imagine. Even as a real estate investor, my leverage and borrowing comes no where near the toxic level Dave Ramsey went to. Why? Because Dave Ramsey’s personality is one of extremes. Much like an alcoholic, he could not control his use of debt. He got one taste of that leverage, and he was borrowing before noon ever day.

Dave Ramsey is a Recovering Debtaholic

Now, he is a recovering debtaholic. Like a recovering alcoholic, he should never borrow again. Why? He just can’t handle it. Put Dave Ramsey and debt together, and something really ugly develops.

Ok, fine. But why should that apply to all of us? It’s as if a recovering alcoholic were telling the rest of the world never to have a glass of wine. In other words, what works and doesn’t work for Dave Ramsey may not apply to everybody else. Of course, there are those who, like Dave, can’t control debt and should avoid it just like he does. But debt — if used wisely — can greatly improve one’s finances, can increase one’s financial freedom, and can greatly improve your balance sheet.

Own versus Lease–there’s really no difference

Being debt-free does not automatically mean you’ve achieved financial freedom. For example, in the world of accounting, there are some intricate rules relating to how a company should account for a lease. Part of the reason for these rules is to prevent a company from appearing to improve their balance sheet when, in reality, they haven’t.

Let me explain. Suppose a company owns a building and has a $1 million mortgage on the property. The mortgage of course is reported as a liability on the company’s balance sheet. So, what if it wanted to get that mortgage off its balance sheet, but still keep the building? Well, it could sell the property and then lease it back from the buyer under a long-term lease. Is the company any better off? No, it’s just changed the legal form of its ownership of the building. It’s still obligated to pay for the building each month, but now the payment is called “rent” rather than a mortgage payment.

We can do the same thing renting a house or leasing a car. You may not have debt, but you do have financial obligations that require monthly payments. And you’ll never own outright the thing you’re paying for each month.

The Real Deal on Debt

So, here’s the deal: being debt-free is not the holy grail of financial freedom. My wife and I could be debt-free quite easily. We could sell our house, pay off all our debt, and have some money left over. I guess we’d then rent a house or apartment, and I would continue to go to work everyday. Would we be more financial free? Nope. I suppose we could move to a less expensive area and perhaps even pay cash for a home. Would we be any more content in life? Nope. In fact, all we’d end up doing is uprooting our family and moving away from a place we love.

Now, the point here is not to run out and start borrowing. But I would suggest considering the following guidelines when it comes to borrowing money:

  1. Avoid borrowing to buy something that’s not a long-term hard asset: That means don’t borrow to go on vacation, or go out to fancy restaurants, or to line your closet with expensive clothes. One of the reasons we are financial free, even though we have debt, is that we have tangible assets behind the debt (our house) that we could sell if we wanted to and be debt-free. Once you take a vacation, you can’t sell it to pay off the debt.
  2. Keep total debt payments below 30% of your gross income: I know that for many this will be very difficult, particularly if you live in an expensive area. But I’ve found that if monthly debt payments exceed 30% of your gross income, life gets very uncomfortable. And I should add that as you get older, this percentage should be going down. It should go down because your income should be going up, and it should also go down as you pay off debt. If you’ve read my articles about how Lending Club sets interest rates, you know that you must have a debt-to-income ratio of 30% or less to borrow from Lending Club. That ratio, however, doesn’t include your mortgage or rent payments. Here, I think it should. The goal is to keep all debt payments, including housing, below 30%.
  3. Borrow wisely: We should all know by now the dangers of variable rate mortgages. Mortgages should be on 15 or 30 year fixed rate loans. Take advantage of 0% credit card offers when it makes sense to do so. You can check out some 0% balance transfer credit card offers.
  4. Don’t spend today what you’ll earn tomorrow: This really ties into the first guideline above. But the point is to control your spending, and don’t let easy access to a loan take your spending out of control. There are plenty of free online budgeting tools you can use that will help you track and control your spending. Use whatever works best for you.

Dave Ramsey is entertaining, and I agree with a lot of what he preaches. And if you choose to avoid debt like he does, I certainly won’t tell you that’s a bad decision. But I also believe that responsible borrowing can improve your finances with modest risk. So what do you think–is Dave Ramsey’s approach to debt the right approach for everybody?

Author Bio

Total Articles: 1118
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

Kevin @ Change Your Tree says:

You’re wrong on many points here, such as leasing vs. owning, and your statement “being debt free is not the holy grail of financial freedom” takes Dave Ramsey’s message out of context.

Dave never says being debt free is the key to financial freedom. If he believed that, he’d only have 2 baby steps.

Instead, he has 7 baby steps. Not only are you debt free, but you have a 3-6 month emergency fund, fully funded retirement, college savings, you own your home outright (you used the example of selling your home and renting, which is not Dave’s plan), and then the last step is to build wealth and give.

It’s a complete financial program that you’ve completely taken out of context. Dave doesn’t tell people not to borrow because he’s addicted to borrowing, he does it because America is addicted to borrowing. The reason the dollar is so weak is because of debt. The reason America has negative savings is because of debt. The reason people are on welfare in retirement is because of debt. This is a huge problem that Dave is addressing and helping to clean up. Preaching against him is taking us in the wrong direction.

Dough Roller says:

Kevin, I’d be interested in understanding why you think I’m wrong on the leasing vs. owning analysis. That being said, I agree with a lot that Dave Ramsey has to say and have written about it. I just think his views of debt are too extreme. All the other points you make about an emergency fund, retirement, and college savings are spot on.

As for America, I would say it’s addicted to spending, and many use debt to feed that addiction. But here’s the key–debt isn’t the problem; we are. For those who can borrow responsibly, as I described in the article, why shouldn’t they?

And finally, I’m not “preaching against” Dave Ramsey. I’m describing why I believe his views of debt are not for everybody. I certainly hope we haven’t come to the point where we are too fragile to engage in a productive, intelligent discussion about debt and personal finance.

This Mom says:

I think that while you provide some valid points, you and I agree on one thing. Dave Ramsey is not for everyone. But neither is Suze Orman, or David Bach, Jean Chatzky, or anyone that claims they know the way to “live right” when it comes to finances. I don’t necessarily 100% agree with your way of doing things, but I’m not going to chastize you either. I’m always willing to listen.

Personally, we’ve tried so many different plans for getting our of debt and controlling our finances. For us, personally, Dave Ramsey works for us. I’m not saying we follow his beliefs 100%, but for the most part, we are following the Baby Steps.

He is not against buying a house, but he does suggest (like you did) to only go with a fixed-rate mortgage, 15 years, and he even goes farther to say that it should be more than 25% of your income, and you should have an established 3-6 month emergency fund first. I agree wholeheartedly.

As far as the cars go, I think his main point is not to have ANY payment, regardless of it being a lease or loan payment. It’s debt either way. Being out of debt (to me) IS the key to financial success, because all the HUNDREDS of dollars we were paying on cars and credit cards each month now can go towards college savings and investments.

Bottom line– regardless of which method people find works for them, it’s a hell of a lot better than sitting by and doing nothing.

I subscribe to about 20 different “money” blogs on my reader, and read them faithfully everyday. Whether I agree with everyone or not, it’s nice to read different ideas and hear varying points-of-view.

DR says:

This Mom, you make a good point that the key is what works for you. As for debt, I think a big step comes when you no longer have consumer debt.

FFB says:

Nice article. It’s important for people to realize that just because a person is an “expert” it doesn’t mean their views should be followed by all. Each of the experts out there has a slightly different take on their approach to personal finance. It’s important to listen to them but we need to understand where they are coming from and how it can apply to us (or should it apply to us). If we understand that then we can be financially free.

I think the biggest problem he has with leases is that most leases are set up to screw the consumer. All the consumer does is look at the payment amount and get suckered in without reading, knowing, or even remotely understanding the fine print.

I agree with you on most points though. If I could borrow $500,000 to buy a $1,000,000 asset, you better believe I would do it. Heck I might even use a credit card!

Erik1904 says:

You never did iterate how being in debt makes your finances better.

Your business example for owning vs. leasing is incomplete, the business would also record the property as an asset and deduct the depreciation. This example clearly points out how businesses “cook the books” to restructure debt.

You are on the mark about Dave being extreme in his approach to debt. Would you not also agree that desperate times require desperate measures. If people in today’s society were disciplined enough manage their finances the over spending so prevalent in today’s society would not exist. If people had the discipline to manage their finances obesity would probably not be a problem either.

Good idea for an article, but you missed the mark.

DR says:

Erik1904, one example of debt improving finances for me is real estate investments. Along with a friend, I own 4 single family rental properties, all with mortgages. In fact, we borrowed 100% of the purchase price and rehab costs for the properties. We did buy them at a 20% discount off of fair market value in an area that didn’t see crazy price increases. I write about this experience at http://www.twowiseacres.com. But that is one example of how debt has improved both my balance sheet and income statement.

As for owning vs. leasing, you are right of course that real estate would be an asset on the balance sheet, but that’s not what motivates a company to enter into a lease-buyback. Also, real estate is recorded at the lessor of cost or market value, which means that long-held real estate that has appreciated significantly is reported at a number that is much lower than its actual value. In fact, if a company has refinanced the property, the debt tied to the property can be much higher than its reported value, particular once you factor in depreciation. So the result of a lease-buyback can have a positive impact on the balance sheet and also result in a substantial gain on the income statement. And a lease-buyback is not itself improper; it happens all the time. The key is in how it is recorded and disclosed.

Mrs. Micah says:

I think your #1 point is critical. Most debt comes from people buying things they can’t afford and that aren’t really assets.

I wouldn’t lease a car because, as Ron says, those are set up to screw the leasee. I don’t know whether we’ll rent or buy a home someday. As you say, either way we’ll have to work. It’ll depend on what’s the best deal, how the area is, etc.

April says:

Thanks for the perspective. Dave Ramsey’s plan works for many. I’m glad for them. But no one can have a fix-all for everything. I am paying on a low-interest student loan right now. I could have been putting more towards it, but instead added extra income to our mutual funds and retirement investments. We got a 15% return on those investments last year. Very worth it, in my opinion.

We work with a CFP we trust for financial advice. He’s proven himself to be a man of integrity. We’re glad to have him.

Totally disagree with the idea of paying off your own home … you should have NO MORE than 20% of your Net Worth invested in your own home at any one time.

You should pay cash for a car … you should finance your house … you should borrow for investments (real-estate, businesses, stocks) and HOLD for the long-term.

These aren’t new or radical ideas, because they work!

Dan says:

I agree with you that Dave Ramsey is not for everyone. However at least he gives a goal to strive for which is easily understandable, and if you obtain it you will likely be in a good position financially. However, it is not the best choice, as you indicated.

My goal is to acheive financial independence. What is that defined as? The ability to live off of your assets without working. In other words, where your money works for you well enough that you no longer have to work at all. At that time, work is no longer a burden but a decision of how you want to spend your time.

Getting to financial independence varies for everyone. Some get there through living a frugal life and getting used to spending very little. Some get there by earning so much money they can’t spend it all no matter how hard they try. In between are folks who live moderately, but save as much as they can in sound and diversified investments. Sometimes this includes investment debt.

I’m still mired in consumer debt, but I hope to be out of that within 4 more years. At that time, all of my debt will be investment level debt. Another 10 years or so of savings and investing, and I should acheive that promised land of financial independence. How I look forward to the day when I can say, I am not working because I have to. I am working because that’s what I want to do with my time. What a wonderful world it will be!

Four Pillars says:

Great post – I’m surprised more of the “Ramsey Rollers” haven’t descended on your blog…:)

Erik says:

I don’t think being in debt ever improves your financial situation, and it didn’t take Dave Ramsey to teach me that.

Your example about owning real estate and getting 100% financing is flawed. I would argue that it definitely doesnt improve your financial situation, because you have just put a lot of risk into your family’s life. What if you lost your job tomorrow or something tragic happened. The last thing you would want to be thinking about is those four properties that you have and the thought of a renter flaking out on you and breaking a lease.

This idea that debt is a great financial tool to become wealthy if you know how to use it is silly. It’s been branded into our heads by banks and lenders, because THAT is how they make money. They want to keep us believing that we can use it to help us, when all it does is help them in the long run.

Sorry, dude. Nice points, but it’s the Hold Grail here. You can’t imagine not owing anyone a dime until you are there yourself. Worth trying and if you miss debt that much you can always go back.


Shanti @ Antishay says:

This is a fantastic post – thank you so much for sharing!

I am an avid DR fan and absolutely love the show. However, I don’t follow his advice to the last detail. For me personally, an emergency fund of $400 was PLENTY to get by while paying off debts, and I chose to attack different debts in their own order for personal reasons… dancing between balance and interest rates for each card. I also intend to retire at 35, if not sooner, and so my financial goals are not to “retire with dignity” at 65-80, but to retire early and have fun for the rest of my life – clearly, my financial pursuits will be more extreme than what he suggests for the long term.

However, I have to disagree with you about the owning-the-house stuff. For your particular situation, yes, selling your house and buying a cheap one does not make sense, but that doesn’t mean that paying it off early would be a bad plan. The minute you don’t have house payments is the minute that you have that much more money to invest or save or spend… whichever you want. I understand that it’s not the right thing for you, but I still think paying off a house is the best plan, always, hands down, for the majority of people out there. Because then it’s free and clear! On top of that, then you can sell if you’d like, or live rent free (or if you consider property taxes, nearly rent-free then) and save like a madman.

As an aside, Dave has no problem with 15 year fixed mortgages, or even 30 year fixed, so long as you pay the 30 of early 😉

Russ Dennis says:

In owning vs. leasing of automobiles, I would say it is always better to own. First if you drive your leased vehicle off the lot and total the car, automatically you insurance will not give you enough to pay off the lease. Secondly, you are always having to watch those mileage charges, Thirdly on the emotional level, I hate paying for something that I don’t own.

I suppose this could be more of a buying used vs. new. I would always buy a few years, low mileage used car. But, I would also always buy new rather than lease. Be careful with used car purchases and look for a good deal.

Christopher Jones says:

This is just slander. Dave Ramsey does not say the things that you are accusing him of — that he would have you sell your house and uproot your family. Nor is his message as simplistic as you make it out to be. I smell envy at work here.

I’m not appointed as Dave’s defender by anybody, and I’m new to the Dave Ramsey show, but this is just trash and a lie. As said, Dave doesn’t say that being debt free is the holy grail of anything. You are lying, and should be called out on it.

Christopher Jones says:

I apologize for the rant (and double post), I’m not usually a flamer. People like Dave give me hope. The post you wrote was nasty and slanderous, it misrepresented Dave and his views. For that I won’t apologize. – CJ

Joel says:

I’m not sure if the original attacks on Dave Ramsey are fair. I don’t agree with everything he says, but hearing his life story on what happened to him and his wife isn’t exactly as you describe – being addicted to debt. In fact, what he did was exactly as you claim to do: “owning” several rental properties (but not really owning any 100%).

To get to the answer to your question, the problem with debt is what happens when things go wrong. Leveraged to the hilt, Dave had to file for bankruptcy when things went sour. I’d rather own 100% of one rental home than 25% of four rental homes, because I’m at 0 risk. In fact I’ve crunched the numbers and when everything is considered, his advice to save and buy a rental home outright in cash is spot on.

One reason for this is the second reason to avoid debt: debt works against you, savings makes your money work for you. I don’t care if mortgages are at an all time low. Saving first lets your money earn interest, borrowing means you pay that interest to the bank. They are getting ahead, not both parties.

Trust me, friend. I have just finished researching this and my decision is to save and buy a rental home outright. My advice to you is to liquidate three of them and try to pay off the first. It *feels* like you are getting more ahead by owning 25% of four homes, but really it’s the same on paper. And when a recession hits and two of your homes can’t find renters because people can’t find jobs, you lose them both. It’s just the law of large numbers that risk is bad and will beat you in the end.

Brad says:

Ramsey has good advice for people struggling with debt and I think the analogy to an alcoholic is a good one.

But most business people only get rich with leveraging, that is, matching a small amount of your own money with a larger amount of (cheaply) borrowed money to buy a business or invest in real estate, hard assets. My father is an extremely conservative businessman, but he borrowed money to open his own store because nearly no one has enough capital to buy their first shop outright. Of course, like the alcoholic, Dave took it to the extreme. You should never be that leveraged.

Furthermore, how long are you going to “save” your money, when time and current interest rates are working against you and you aren’t even keeping up with inflation? Investing in a quality rental property (given that you’ve done all your research and due diligence) makes leverage work for you. Sure, the economy can turn bad and the whole thing, including your stocks and your savings can go belly up (you really think FDIC is “insurance?”), but then again, we are all in service to the Federal Reserve fractional banking system at that point…

Jeremy says:

I recently bought my first triplex for 3.5% down. My p.i.t.i. payments are $628 a month and the rental income is $1100 a month from 2 units and I live in the 3rd unit. Thats a net profit of $472 a month!! plus a free place to live!! and there were already long term tenants occupying it so I started making money day one. I see many more deals out there just like this one. I would say Daves plan does not apply to this current market of low interest rates combined with low housing prices. I mean come on, I am putting close to $1000 a mo. more in the bank than I was before I bought this house and I put almost no money down.

I would also like to say that by not taking a risk, you ARE actually taking a risk. You are taking a risk that your money is being devalued every second it sits in that bank account making less than 1% interest. Nothing is risk free.

Rob Berger says:

Jeremy, that’s a fantastic investment. I suspect Dave wouldn’t make too much of a fuss over debt to buy real estate as you have done. I know consumer debt drives him crazy, as it should!

Michael Granger says:

I agree with the premise of your argument in regards to Dave Ramsey’s inability to properly manage his borrowing capacity. I also find him to be entertaining but am frustrated by his dogmatic views on debt. I wouldn’t be where I am today if I couldn’t borrow money to pay for my education. Sometimes you have to borrow money to invest in yourself. I doubt many of his acolytes could completely avoid debt anyway. His philosophy is rooted in idealism and lacks any degree of pragmatism needed to build a future.

Justin says:

Rob, just read your article and I agree with some of your points. The point that I don’t agree with is the peace of mind. You can’t honestly say have a grand in the bank is the same as not having a grand in the bank. I followed Dave’s plan nine years ago and paid off all debt except my mortgage and I didn’t live on beans and rice. My debt was relatively low compared to most, about 30K. I paid off my mortgage two years ago and I would not have changed a thing. We modified the plan to our needs and didn’t go the “gazelle” route. But as for the peace of mind of owning my cars, home and everything else, I will stick with Dave until the end. He has helped me greatly and I didn’t pay him a dime. I got his book free from the library and just read it. Too easy.