Have you increased your debt load from last year? How about increasing your debt load every quarter for the last five and a half years? I hope you have not, but unfortunately American citizens, in aggregate, have done just that, increasing the amount of money they owe for 22 straight quarters to a staggering $14.15 trillion. For a breakdown of this debt, please see the third paragraph of this week’s Weekly Market Review.
Dave Ramsey takes a hard line on debt and I can understand his position. His get out of debt as fast as possible no matter the consequences, is a recipe for eventual financial safety, and for the most part, I think it is good advice. Like most things, I believe there are exceptions and debts that can be considered good debts on your balance sheet.
A couple of potentially “good debts” are:
- A home mortgage financed at a low rate. Most folks with good credit can qualify for a fixed rate loan in the 3% - 4.5% range. This interest is tax-deductible assuming the mortgage is on your primary residence. Depending on your income tax rate, the real cost of that mortgage interest could be as low as 2%. While owning your home free and clear is a financial goal most all of us share, in a scenario like the one I’ve just described, it makes a lot of sense to pay that mortgage payment as scheduled through the very last payment and take and additional funds available and invest them. The return rate needed to be money ahead is a modest 3.5% - 5% and that assumes you aren’t investing money into some sort of tax advantaged account such as a 401(k) or IRA.
- Interested in comparing your mortgage rate to current mortgage rate offerings? Click here
- A debt against a real-estate investment such as a rental house. A tenant paying your mortgage for you via a rent payment can be a good debt. This assumes the real-estate investment is a good investment in other ways also. Right now, in the middle Tennessee area, cap-rates have become compressed because real estate values have increased faster than rents have increased. The lower the cap-rate the thinner the investment gains will likely be. The exception to this would be real estate that highly appreciates while you own it. High appreciation of real estate values can be hoped for and even expected, but certainly not known or guaranteed.
- Interested in better understanding cap rates? Click here
Debt can be a useful tool, but it can also burn you fast and leaves you less flexibility to manage through a financially difficult time brought on by something unexpected such as a job loss, disability, or sickness. A best practice is to decrease your debt load over time and create a cash-flow cushion for yourself in order to better weather the unexpected; and when able, take that cushion and invest it.
In the long-run it is far better to earn interest than to pay it.
As always, we hope you find the Weekly Market Review both informative and interesting.
Trevor N. Coe, CFP