Payczech’s Advice On Financial Debt

If you have ever read my blog, watched my videos, took my online courses, or attended one of my classes, then you know how I feel about debt. Debt is the “anti-wealth,” and actually that is not even my opinion – it is a mathematical fact…

Assets – Liabilities = Wealth

Obviously, if we want our wealth to increase, then we need to increase assets and decrease liabilities.

Personally, I believe in living debt-free. With that being said, I am also realistic. I understand that not everyone is going to stay away from debt. As a result, I am comfortable with teaching people how debt works, and giving them the information they need to make sound decisions for themselves. Here are my thoughts on the more common types of financial debt.

Credit Cards

I do not have a personal credit card. As a result, I cannot in good faith recommend credit cards nor advocate their use. However, I can tell you that credit cards are preferable to some types of debt, like payday loans.

Carrying a balance month-to-month does not provide much benefit. Unfortunately, a large number of people have bought into the myth (perpetuated by credit card companies) that carrying a credit card balance is good for your credit score. The reality is far different.

If you carry a balance month-to-month, you incur finance charges (interest). The effect that credit cards have on your credit score has nothing to do with how much interest you’ve paid. It has to do with “credit utilization.”

If you are trying to build your credit score – it is important to understand that your credit score will appreciate just the same if you pay off your credit card each month. Paying interest has absolutely no effect on your credit score.

Car Loans

I used to have a car loan and I will never do it again. Why? Because cars go down in value, are subject to accidents, and once you take out a car loan, you will stay on the payment merry-go-round for years to come.

Unless you are wealthy and can afford the waste money on a brand new car, buying used, dependable automobiles for cash (no lease or loan) is mathematically the best decision. If you absolutely must get a car loan, then getting a small loan that can be paid off quickly (in two years or less) is the best way to go.

Home Mortgage

It is important to note that renting is a totally acceptable means of having a home, and there is nothing wrong with renting. Many people like to say that renting is like “throwing money away.” By that logic, paying mortgage interest and private mortgage insurance (PMI) is also like “throwing money away.”

I get it. We all want to have a home. A home is a status symbol, and it is a manner of comfort. However, we need to recognize that it is a financial decision and we cannot let our emotions get in the way. Here are five ways that you can ensure that a home mortgage becomes a useful financial tool, as opposed to a financial nightmare…

  • Have no other debts (or very little debt that can be paid off in a couple of months)
  • Fixed rate 15 year loans only
  • Have 20% equity at signing (20% down-payment, 20% discount, or combination of both)
  • Payment should not exceed 25% of your income
  • Have an emergency fund equal to 3 to 6 months of expenses

Student Loans

It is important for people to set borrowing limits BEFORE they start taking out student loans. If you have already taken out student loans, it is not too late. You can still follow this exercise to see whether or not you have taken out too much.

The rule that I teach is called The Rule of 85. It is not an exact science, but it does a great job of helping people determine how much college debt is too much.

First, take your expected annual income after college graduation and multiply it by 10% (or 0.10), then divide by 12. The result will be the most you can afford in terms of a monthly payment on your student loans. Multiply this figure by 85 and the product will be the most that you can afford to borrow in total.

For example, someone expecting to make $36,000 per year should not borrow more than $25,500 (using The Rule of 85).

Under no circumstances should your monthly student loan payment exceed 20% of your income. That is dangerous territory!

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