Apparently I Feel Differently About Debt

Personal finance is really a pretty basic topic. For most people, money and what to do with it is just not that complicated:

• Spend less than you make.
• Put aside 10/15%+ for retirement.
• Don’t use a credit card, or if you do, at least don’t keep a balance on it.
• Pay off your debts as quickly as possible.

The last one is a little different for some though, at least for certain debts. Some are just fine with a little — or, more likely, a lot — of debt if it’s on your house. Or your student loans. Good debts. Debts on assets that earn.

Well, unless you bought a house in an area where the market is now melting down. The luster is off that house with a rapidly adjusting ARM worth 70% of what you paid 2 years ago. Likewise that $100,000+ masters degree in philosophy that allows you to eek out a living on $30,000 a year.

Still, there seems to be two groups who argue that paying extra on their mortgage or student loans debts is not for them, even if they can afford it:

“I’m Saving a Ton On My Taxes”

But wait… isn’t there a tax benefit with those two types of debt?

Oh, sure, if you think sending the bank $10,000 in mortgage interest to save $2,500 is a smart move. That’s assuming you would itemize without the mortgage anyway. If you are like most, and the only reason you qualify to itemize is because of mortgage interest, the ’savings’ is likely much less. Personally, we don’t see any advantage at all because we won’t itemize either way.

At least with a student loan interest, there is a tax benefit (but with the same trade-my-dollar-for-your-quarter nonsense) irregardless of whether you itemize or not. Unless, that is, you are single and make more than $50,000 ($100,000 if married) when you begin to get rapidly phased out of the deduction. But the real problem to me is: are you really fine paying on money, albeit borrowed at an ultra cheap rate of 2-4%, for a degree you earned 30 years ago, in a field you might not have worked in for 15 of those years? Long after which, the tax benefit becomes almost nil, as the deduction based on student loan interest paid, not on student loan payment?

“I Earn More by Not Paying My Debt”

With the low interest rate on those debts, isn’t the money I have better spent increasing my investments than decreasing those debts? And won’t paying the debt off with the earnings from those investments be quicker than directly paying them down?

Possibly.

For instance, right now we’re paying 5.69% on our mortgage. I’d be hard pressed to come up with a short-term investment that would beat that rate (which would be 7.6% pre-tax earnings) without taking on quite a bit of risk. Over longer terms, it is not a particularly difficult target to beat – a simple index fund should handily beat those returns over a, say, 15-year timeline if history is any indication. But of course, “Past performance is no guarantee of future results“.

The ultra-cheap student loan is a bit easier: a investment returning 5.34% pre-tax beats a 4% loan (by all of .005% , but it does beat it). Short-term investments are still a little iffy (but certainly not out of the question), but long-term should really be a no-brainer.

So at least over the long-term, financially it may make a sense to invest what you would otherwise prepay.

Not In Either Camp

Neither argument works for me.

The tax dodge route is, I’m sorry, just stupid. Paying a buck to get a quarter back makes you a moron. I don’t care if it brings your cost to borrow down to 1%; it’s still debt that you can do something about but you chose not to.

Using available funds for investing rather than debt repayment at least makes a bit of financial logic, though I think most who follow this route overestimate the potential returns and, more importantly, underestimate potential risks. Of course, the argument assumes one actually invests what would otherwise go to prepaying rather than just ratcheting up consumption. Or that one would use that future money to pay off that debt rather than, oh, buying a nice shiny new Lexus. There are some out there that are that disciplined, and god bless ya’… but I have a sneaky suspicion that most are not.

Nevertheless, we won’t be following the ‘logical’ route either. Probably because I don’t see debt the same way proponents of either method see it. To me, there is no distinction between good and bad debt. Debt is debt – an obligation to pay something to someone. What the debt was taken on for initially is really immaterial, and the quicker I can get it out of my life, the better.