Debt does not allow you to buy things you couldn’t otherwise afford. It simply lets you buy things sooner, in exchange for interest and added risk.

There is a super common misconception about debt. People believe it allows you to buy things you couldn’t otherwise afford.

This is false (except for housing and school).

Debt allows you to buy things today that you otherwise wouldn’t have the money for until later. All debt does is bring your future purchasing power forward to today. Debt does not increase your total lifetime purchasing power.

I have heard a million times: “I can’t afford to pay cash” from someone who wants to buy some high-ticket item. This is false. What they mean to say is “I can’t afford to pay cash today, but I want it today!”

However, the truth is that if you can “afford” the payments on an item, then you can “afford” to save up and pay cash. You may just have to wait a bit to bring the thing home.

Sofa Now or Sofa Later

For example, let’s say you have no money but you want this $2,400 sofa from Costco. And, let’s assume you can find a 12-month 0% financing deal somewhere, so for just $200 per month that sofa can be yours today.

But that’s not the only option. If you can afford the $200 monthly payment, then you can afford to save $200 per month toward this sofa now and pay cash for it in a year.

So, if you are willing to make the payments on this sofa, why aren’t you willing to save up? Most people would say that since the financing is 0%, there’s no harm in just getting payments. Well, most people are broke. And, I don’t take financial advice from broke people.

It turns out, there is an extra cost for financing the sofa, even if there is no interest. That cost is risk.

The Risk of Making Payments

What’s your credit score? Is it over 800? If not, I would be willing to bet that is because you have missed a payment before.

It’s okay, almost everyone has been late on a payment for one reason or another.

What happens when your plan is to save $200 per month for a $2,400 sofa and you miss a month? Not much. You just have to push the purchase date back a month.

What happens when you miss a payment on a $2,400 sofa that you financed with a 0% interest, 12-month loan? Usually, the interest rate jumps from 0% to somewhere north of 15%. And, you owe interest for the entire duration of the loan, not just the time when you were delinquent. So, the risk is that your $2,400 sofa could end up costing you over $2,700. Plus that late payment will likely damage your credit, which could end up costing you additional interest on other loans… like your mortgage.

That is a lot of risk to take so that you can buy a sofa one year earlier than you would have with cash.

Use Debt Responsibly

I don’t hate debt. I have used lots of different kinds of debt over the years. In fact, I have used pretty much all kinds of debt except payday loans or those Rent-to-Own stores. Happily, I have been able to avoid those horrifyingly expensive payment arrangements.

What I have learned about debt is that fast-forwarding my purchases by a few months did not bring me any more enjoyment out of the items I was buying. In fact, because I had a payment, I was reminded that I was still paying for the thing every time I used it. So, I think my lifetime enjoyment of these things that I had financed was less than if I had saved up and paid cash. Which is one of the reasons I don’t finance anything any more.

The extra stress and risk associated with making payments on almost everything is not worth it. That’s why I only recommend using debt for real estate, cars, and school.

Use Debt For Real Estate

I don’t mind using debt when buying a house. For most of us, saving up to pay cash for a house would take years or even decades. Houses are almost always going up in value, so buying in earlier means you can pay less.

However, buying too much house is irresponsible and dangerous. Just because you can qualify for a specific mortgage doesn’t mean you can afford it.

For real estate, I use the 20 / 3 / 15 rule of thumb. Put 20% down. Spend less than 3-times your annual gross pay, and keep the payment less than 15% of your monthly gross pay.

Use Debt for Cars

I don’t mind using debt when buying a car… sometimes. Driving an old junker for 4 or 5 years is unpleasant. Plus, very old models can cost more than their worth (in money and effort) for maintenance and repairs.

However, buying too much car is irresponsible and dangerous. Just because you can qualify for a specific car payment doesn’t mean you can afford it.

For cars, I use the 20 / 4 / 10 rule of thumb. Put 20% down. Take a loan for no more than 4 years. Payments should be no more than 10% of your gross pay.

Check out the full article about real estate and auto loan rules of thumb.

Use Debt for School

I don’t mind using debt to pay for education. Some high-paying careers require a degree or certification in order to receive higher compensation. It can be very difficult to save up enough to pay for school on the salary you make before you go to school.

However, buying too much education is irresponsible and dangerous. Just because you can qualify for a specific student loan doesn’t mean you can afford it.

For education, make sure that your income will actually go up as a result of your education. Do not take out more than 2-years worth of the extra income you expect as a result of your education. Then, pay the thing off as soon as possible after graduation.

Check out the full article How to Decide if Student Loans are a Good Idea.

Avoid All Other Debt

Real estate, car, and education loans are the only kinds of debt I recommend.

Want to buy a sofa? Save up and pay cash.

Need a new HVAC? Use your emergency fund.

Want to go on a trip to Mexico? Save up and pay cash.

I know that interest rates are at historic lows. It is possible to finance almost any of these things at 0%, same-as-cash, rates. But the true cost of financing is more than just the interest rate. It is the risk that you take.

If you stop using consumer debt and start paying up-front for everything you buy, I guarantee you will get more enjoyment out of the things you purchase.

Try it, I promise you will like it. And, if I’m wrong and you miss having monthly payments, you can always go back into debt!

Final Thoughts

I have heard a million times that debt allows people access to things they couldn’t otherwise afford. As a society, we owe it to lower-income people to make sure they have the ability to borrow money!

This is a lie. It was created by lenders (who profit off this arrangement) and has been perpetuated throughout our culture.

Debt does not give anyone access to things they couldn’t otherwise afford. It just allows them to buy it earlier than they otherwise could.

Sure, real estate and education are exceptions. Houses are almost always increasing in value, so borrowing can actually make the cost lower than saving up. And, sometimes you have to go to school in order to get that higher paying job that would allow you to be able to afford to go to school.

I’m also not opposed to a reasonable auto loan. Interest rates are currently incredibly low, and saving up for a car for 4 years while driving an old junker isn’t very pleasant. But, that is not an excuse to go car-crazy and buy something you cannot actually afford.

For everything else, I’m allergic to debt. I absolutely refuse to pay more for an item than is necessary, so I’m definitely not going to finance a sofa at more than 0%. But, I’m also not willing to add risk to the purchase by putting it on payments. It’s a sofa. It should help me relax, not bring risk into my life!

I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.

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