Payczech’s Advice On Financial Debt

If you have ever read my blog, watched my videos, took on online course of mine, 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; that is a mathematical fact…

Assets – Liabilities = Wealth


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

I believe in living debt-free. I believe in it because I currently live it, and it is awesome. So my first rule is to avoid debt if at all possible.

With that said, I am realistic. I understand that I will not convince everyone to stay away from debt. Dave Ramsey cannot do it, and I cannot do it. As a result, I have come up with some simple guidelines when it comes to debt. These guidelines are the results of years of study, and years of writing and teaching personal finance.

Credit Cards

I do not have a personal credit card (aside from a company card from my current employer, but that is different than a personal credit card). As a result, I cannot in good faith recommend credit cards nor advocate their use. However, if I cannot talk you out of it, then the rule with credit cards is simple: never carry a balance month-to-month!

If you carry a balance month-to-month, you incur finance charges (interest). Why pay interest when you should not have to? Why only pay the minimum?

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, I advocate buying used, dependable automobiles for cash (no loan). If I cannot talk you out of a car loan, then be sure that you can realistically pay off the loan within two years.

And don’t get me started on leases. Leasing is mathematically the most expensive way to purchase a car.

Home Mortgage

I have five rules when it comes to home mortgages…

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

These guidelines may sound strict. However, they all have very good reasons and are backed up by research that could fill a book. There is nothing wrong with renting while you save up a sizeable down-payment.

If renting is “throwing away money,” then what about mortgage interest and mortgage insurance?

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 definitely does a good job of helping people find the “line in the sand.”

First, take your expected annual income after college graduation and multiply it by 10% (or 0.10), and 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).

Keep in mind that this rule assumes that you are living alone and have many of typical household expenses. If you split household expenses with someone, or if your spouse is the breadwinner and takes care of the household expenses, then you could a little more than what The Rule of 85 would suggest.

Under no circumstances should your monthly student loan payment exceed 20% of your income.

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