• Anne

Get out of debt!

Updated: Apr 30

Do you love your debt?

I’m going to venture a guess that you don’t. As a math person, and a Dave Ramsey follower, I HATE debt. I avoid it like the plague. I’ve never had it in my life until a week and a half ago (we bought a house!) and it drives me crazy when people seem to think they “beat the system” with debt.



I might be about to upset people here

I am so confused when people actually want debt. If given the option, people don’t want to pay off their debt so they can have a credit score (you can have that with a credit card you pay for in full each month). People focus on their monthly payments and forget how much they are actually paying for it. If you do the math, $0 down and $X per month is never a better price than paying in full up front!


What about 0% financing?

While 0% financing sounds great, it is always for a certain amount of time, like 6 months. The problem is they are actually keeping track of your interest, so if you don’t pay it off within that time frame, you suddenly have a bunch of interest dumped on you. Say you buy an $800 TV with two year, no interest financing, with 20% interest. Let’s say you make all your regular payments, but miss the last one and you’re hit with a $250 charge for the past interest you accumulated (and the remaining ~$30 balance). You know who never gets hit with those charges? People who pay upfront.


Doing the math with cars

Let’s say you buy a $25,000 car at an interest rate of 6% for a 7 year loan. Your payment would be around $365 per month. $365 doesn’t sound bad, until you multiply it by 84 months. Then it becomes $30,660, so you paid over $5,000 in interest alone (20% of the original price!).


Doing the math with credit cards

Let’s imagine what happens when you have a credit card with a 19% rate, but you only make minimum payments, while spending $1,000 per month on the card.


See how not only your balance and interest are skyrocketing, but your minimum payment is too!

Doing the math with mortgages

Now I know a lot of people will say you shouldn’t pay off your mortgage early because A) you get tax benefits or B) you can invest at a higher return.


If you’d like, you can see Dave Ramsey’s response to both:

Dave’s reply to A

Dave’s reply to B


Let’s say you buy a house for $300,000 with a 20% down payment at 4% interest for a 30 year mortgage. Your payment might be around $1,429.13 per month, with $1,145.80 going towards principal and interest and $283.33 going towards taxes and insurance. Let’s also say that you can put $2,000 towards the mortgage per month, before utilities.


Now I’ll crunch some numbers and show you what happens over the course of thirty years if you invest at 9% return vs. paying off your mortgage and then investing. I’ll even account for a 1% growth in home value.


The flat portions of the curve are zoomed in when one is mortgage-free.

As you can see here, the person making extra mortgage payments ended up paying off his mortgage in Month 189 (15.75 years), while the person who invested instead paid the full 360 month term. Now you may notice that indeed, the person who invested does come out ahead in net worth, at $1,459,431.07 while the one who paid off his mortgage early has a net worth of $1,007,458.87. This is why people tell you not to pay off your mortgage early. Exclusively using the numbers with very consistent returns does end up pointing towards investing, since it’s a higher rate of return.


(I would like to point out on the side though that the person who paid off the house early only spent $83,648 on interest, while the other guy spent $172,459 on interest alone.)


What’s missing?

The problem with this logic is it doesn’t account for risk. There is significantly higher risk in having a mortgage for 30 years. Now, I love investing as much as anyone, but the market can be very volatile. The long run returns are great, and there is more liquidity in investments than your equity in a house.


However, if you pay off your mortgage early, you free yourself from payments and a lot of fear. If you pay off your house and don’t have a payment in the world to make, your expenses go way down and you won’t have to fear losing your home during a tragedy. As such, there is much less risk and more security in paying off your house early.


That being said, certainly do invest some during this time. Compound interest is powerful stuff, and you should be putting a good amount towards retirement and investments, but don’t neglect the house.


“100% of foreclosures occur on a house with a mortgage.”

-Dave Ramsey


The debt snowball

If you have debt, I highly recommend you use Dave Ramsey’s debt snowball. Mathematically, it doesn’t make as much sense as paying this highest interest debts first, but like he said, (paraphrasing) If you were good at math, you wouldn’t be in debt. It’s based in behavioral psychology. You take your debts from smallest to largest and knock each one out.


Challenge

If you don’t have debt, give yourself a pat on the back and treat yourself to a nice evening out. If you do have debt, make a plan today to get out of it. Sit down with a spreadsheet, crunch the numbers, create a budget, and make a timeline to get out of debt ASAP. That’s exactly what I did before I even called the mortgage lender. Debt is the master and you are the slave - don’t keep yourself in slavery longer than you have to!

Disclosure

Some of the links on this site are referral or affiliate links, meaning, at no additional cost to you, I will make a commission if you make a purchase through my link.

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