Smart Borrower Center
Tools to help you borrow better
By Bridget Smith - Editor-in-Chief, Smart Borrower Center
Wouldn’t it be wonderful to be debt free? No mortgage, no car loans, no student loans, not even a credit card balance? For most of us, being debt-free is something we all aspire to.
I’ve been thinking about the whole debt-free issue after talking recently with Kelli Grant, a reporter with SmartMoney magazine, for an article she is writing on the topic. Most of us assume that being completely debt-free is the ultimate goal – as so clearly stated in Shakespeare’s famous phrase “neither a borrower nor a lender be.”
Debt is a financial tool
Is debt really all that bad? The answer is no. There is good debt, and there is bad debt. And there are times when debt makes sense, and times when it doesn’t make sense. A loan isn’t a vice – it’s a tool to use to meet your financial goals, much like a CD or 401(k).
Sure, I work for LendingTree, but I’m also a borrower. And while it’s obvious that lenders benefit from debt (they profit, of course) there are benefits to the borrower beyond just building a credit history.
Building assets and building wealth
Debt allows you to build assets; for most people, this is in the form of a home. My husband and I would not be able to afford to buy a home with the money we have in the bank, but with a mortgage it’s attainable. And then comes the good part. Home ownership doesn’t just get you a mortgage interest tax deduction. Homes tend to appreciate over time, so the asset – in this case my home – is worth more every year. We’re lucky enough to live in Charlotte, North Carolina, where home prices have steadily increased over the past 10 or so years, so we’ve been able to build quite a bit of equity in our home. We can tap that equity for a renovation, a new car, even an emergency, if needed.
Even in areas of the country where home values dropped in 2006, housing has been a fantastic investment overall for the past 5 years, with a 9.2 percent gain in the U.S., according to Freddie Mac’s Conventional Mortgage Home Price Index. Because housing appreciated dramatically in the early part of the decade, that’s above the typical rate, which is closer to 4 to 5 percent.
There are other types of debt that help you build wealth. Borrowing for education is one, and it’s something I took advantage of a few years ago in order to go to graduate school. While an education isn’t a tangible asset, it allowed me to gain skills that increased my income. And since federal student loans are one of the cheapest ways to borrow money, the amount that I paid for my student loans – my interest rate – is lower than pretty much any other borrowing tool available.
To pay or not to pay?
But now that we have all this debt – how quickly should we pay it off? It’s a question that my husband and I ask each other frequently.
My husband is one of those rare financial souls who strives to live debt free – and, for the most part, succeeds. I’m more comfortable with debt to a certain extent, and want to take advantage of “good” debt. (“Good” debt is debt that leaves you with an asset or helps you achieve a financial goal, while “bad” debt is debt you use to live beyond your means or debt you don’t understand.)
The loan in question is my student loan. My payments are less than $300 per month, but when I consolidated the loan I locked into a 15-year term. I’m now asking myself: Do I really want to be paying student loans well into my 40s? Without doing the math I would say no way.
But taking a closer look, the answer isn’t as clear. In the case of my student loan, I compare the interest rate I’m paying on the loan with what I’d earn if you put that money elsewhere. My interest rate is fixed at 2.75% (I was lucky and consolidated my loans in 2004, when interest rates were incredibly low). With a rate that low, I can get a better return putting additional money into our savings (a money market account that earns 5%) than I would accelerating my payments on the student loan. If our cash flow changes (or when I’m 40 and still paying a student loan) we may revisit our decision, but for now we’ve decided to leave the student loan as is.
Being able to sleep at night
Not all of us are Donald Trump. Trump has made a lot of money because he clearly understands how to use debt, and he can tolerate the risk that comes with debt. But if having any kind of debt – regardless of the type, the interest rate and your return on investment – keeps you up at night, or if you’re not sure you fully understand the debt, then paying it off quickly is probably the right answer. At the end of the day you need to know what makes you comfortable, and go with that. But simply wanting to be completely debt free may not be the path the wealth, either.