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One of the greatest feelings I have experienced was becoming completely debt-free in April 2015.
I was incredibly proud of achieving this feat just 4 years after hitting my financial low, clawing my way back up from being $850k in debt and having just finalized a brutal divorce that left me financially crippled.
It was liberating knowing that the money that I was bringing into the household was no longer being siphoned away to service debt and letting others profit from me.
In the lender-borrower financial spectrum, I had felt strongly that it was always preferable to be on the lender side.
It therefore may seem a bit strange that I have recently started changing my views about debt.
Traditionally debt has been broken down into two categories, good debt and bad debt.
Good debt is debt incurred to obtain assets that will in turn generate cash flow.
Mortgages on rental properties or loans obtained to start or maintain a business typically qualify as good debt.
Even student loans can be considered good debt if the degree earned can generate cash flow that outweighs the cost of the debt (medical school debt certainly falls into this category (for now)).
Bad debt, typically known as consumer debt, is debt incurred to buy items that tend to depreciate with time.
These items are not expected to bring positive cash flow to the borrower and are typically a liability on the balance sheet.
The debt debate.
When I first decided to pay down my 30 year fixed (5.625% APR) mortgage I came across numerous articles that suggested I would be better served to put that money into the stock market/investments instead.
The arguments were compelling, especially since we were in the middle of an epic bull run (although I did not know it at the time).
Instead of getting a guaranteed 5.625% return on my money by paying off the mortgage early, I could have made double digit returns in the subsequent years.
Unfortunately hindsight is 20/20 and there was a possibility that the market could have crashed shortly after I had put money into it if I had indeed chosen that route.
I justified my choice and reconciled the “money left on the table” from paying my mortgage early with the peace of mind I obtained from being debt free.
It is hard to explain it (it is just something you have to experience yourself), but when you no longer have debt, consumer or otherwise, there is a huge weight lifted off your shoulders.
You are better able to tolerate any future financial hard times that may occur because there is no threat of losing the roof over your head.
Emergency funds therefore do not have to be as robust as those emergency funds where you have to still account for continued debt payments in addition to the financial emergency itself.
As a last resort you can even tap into the equity of a fully paid home by obtaining a HELOC to help bridge the time til you get back on your feet.
If I had to revisit my decision in 2015 on whether or not to pay off my mortgage early I would still make the same choice.
Change is in the air.
Recently I have been debating about how I would approach debt for any potential future purchases.
Even though in the past I admitted that I lied about being debt-free, today I still consider myself to be debt free.
(Sure I have charges on my credit cards but those balances are wiped out typically bi-monthly (in conjunction with my paycheck).)
But now I am not so sure paying off debt early is the wisest move, regardless of potential investment returns.
What has caused this mindset shift?
It mainly has to do with the current economic environment we find ourselves in.
The United States, along with the vast majority of countries in the world, has painted itself into a corner with its fiscal policy.
It is hard to avoid talks of ramping up inflation by the media.
What was originally promised as a transitory period of inflation by those in charge is starting to look more like something we have to deal with on a much longer term basis.
Our FIAT currency, which no longer has a tangible asset backing it up like gold pre-1971, allows the government the means to devalue it.
What makes things worse is that the majority of the Governments in the world are incentivized to devalue money:
- It makes paying back national debt easier by paying it with less valuable dollars.
- By letting the money printing machine go BRRRRRR, the flood of dollars into the system typically finds its way into the stock market elevating prices, making its citizens happier thinking they are getting wealthier.
- However I previously demonstrated that in this type of environment we might not be making financial headway at all.
When you can’t beat em, join em.
So given that there is no foreseeable end to the money printing spree our government is currently on, it is likely that inflation will have an ongoing significant impact in our lives.
Costs of goods and services will go up.
The dollar will continue to have its purchasing power diminish, and thereby punish the savers and those who live on fixed income alike.
So what can us hapless citizens do?
I say we take a page right out of the government playbook and fully utilize the opportunities present with debt.
We are in quite an interesting time economically.
As mentioned above the government has its hands tied and continues to flood the economy with dollars.
Uncle Sam now has an incredibly tight balancing act, trying to avoid hyperinflation (which would certainly cause an uproar amongst its citizens) while trying also to keep interest rates low so that the economy might recover.
So how can an individual take advantage of this situation?
By doing what the government is doing and going into debt!
Okay, I haven’t completely lost my mind here, so hear me out.
Because the government has yet to make significant interest rate increases to curb potential hyperinflation, we are in a potential window of borrowing opportunity.
Mortgages, car loans, etc can be had for relatively low interest rates currently.
With the current inflation rate reported by the government at 6.2% (I still feel inflation is being way under reported), there is a potential interest arbitrage you can capitalize on if you can lock in a low interest rate loan.
Even if you have the money to buy the asset outright, you will come out ahead, in terms of purchasing power, if you instead take the full amount in a loan and just park the money into a savings account.
Running some numbers as an example.
For simplicity sake let us say you were interested in purchasing a home outright with cash.
Current 30 year fixed mortgage interest rates are around 3.5% at the time of this writing.
Also for simplicity sake, let us say that the rate of inflation will be 5% for the life of the loan (even though the government would like to keep it under 3% I just do not see this happening any time soon).
My “high yield” Ally Savings account offers a 0.5% interest rate.
Right off the bat you can enjoy a risk-free 2% interest arbitrage (5% inflation minus 3.5% interest for loan minus 0.5% savings interest) by putting your money in a savings account and slowly paying down the loan with your original capital.
[Note: It was pointed out by an astute reader who commented below that I failed to account that the money in my savings account would essentially be devalued as well because of inflation and not be in a vacuum as my example required (thus only way to take advantage of potential inflation arbitrage would be to have the money in an actual hard asset (real estate, stocks, etc)]
If by some miracle the government manages to reverse inflation (I am not holding my breath), you can always choose that moment to pay off the remaining balance completely.
In essence you are keeping more valuable dollars initially and paying back with dollars that are being devalued (i.e. decreased purchasing power).
If the true inflation rate is even higher than what is reported (some estimate it at 15%), the difference is even more striking.
This example shows the potential opportunities at play with “good debt.”
This strategy would not work well with “bad debt” such as consumer credit card balances where the exorbitantly high interest rate charges (often over 20%) trump any gains from arbitraging inflation.
Of course I am not a financial advisor and it is wise to do your own research and come up with a plan that benefits you the most.
But this is just an example of why being in debt may actually have you come out ahead in the long run.
If you are in search of financial help, please consider enlisting the service of any of the sponsors of this blog who I feel are part of the “good guys and gals of finance.”
Even a steadfast DIY’er can sometimes gain benefit from the occasional professional input.
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I’ve been debt free my whole life except for a mortgage for the past 20 years. At 3.30% I’ve made the calculated decision to keep it as my money is better served in the market, and that decision has been very wise. Even my bond index funds have outperformed 3.3%. I have no plans to pay my mortgage off right now
You definitely have come out ahead Dave by keeping the mortgage. If the dollar continues to devalue at its current trajectory you will reap the benefits even more down the line.
Great take I am completely debt free but I find that the relief of not taking out debt is more comforting than worrying about making the payments. I know can cash flow as much into investments which is a good way to hedge against rising inflation.
Thanks Keith. I agree that no monthly debt payment provides a great amount of relief in case something does happen to your cash flow. But man oh man it is hard to ignore the interest arbitrage right now between inflation (this past November is another record high) and the interest rates out there. It’s like you can make money by just borrowing it and putting it a savings account which is ridiculous. All governments are caught between a rock and hard place because they do not want to raise interest rates because it would make their own debt unserviceable
Unless the interests gained on the saving account beats the interest on the loan you’re still losing money (regardless of the inflation rate), I can’t understand the argument.
Your money parked in the saving account earns half a percent and loses real 4.5% after considering the inflation rates, however if you pay the debt with that it gains 3.5% and loses 5% to inflation so you’re down -1.5 (compared to -4.5%), Am I missing something?
You are absolutely correct. I think I had a brain freeze trying to come up with a low risk example. I forgot to account that the money in the savings account also deflates and loses purchasing power (in my example that money magically didn’t debase which is impossible).
So the only way to take advantage of currency debasement is to buy an asset (like real estate or a commodity) that does not debase. Thanks again for pointing it out (in my mind it made sense at time of writing. Lol)
Have a happy new year
Happy new year! and thank you for clarification.
As far as real estate is concerned, do you have a post about your favorite or recommended funds? I have invested the minimum amount in origin investments (IncomePlus Fund) and have heard of DLP as well (but not sure if I can trust them).
I enjoy your blog alot, keep up the good work, Cheers!
Thanks KD (I’m still kicking myself for making that rookie mistake, lol). As far as real estate, I have 56% of my portfolio in real estate syndications. Originally (I started May 2017) I had syndications with individual apartment complexes (the first syndicator I ever went with was 37th Parallel, came across them because of Dennis Bethel who was an ER doc and had posted on White Coat Investor). I currently have 8 active investments with them and it accounts for nearly 50% of my real estate investment. The IRR for all these ranged from 2.98%-6.35%). Haven’t had any issues/complaints. Dennis… Read more »