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Friday, March 31, 2017

Keeping Debt Small

Posted by Tim Stobbs on November 17, 2008

Perhaps over the last two years you’ve noticed something on this blog.  I typically don’t write a lot about debt.  After all I don’t have much myself other than a modest mortgage on the house and a line of credit that was used to buy investments.  I’ve never carried a credit card balance for longer than a two month period (which only happened once while moving between jobs).   Actually all in all my credit report is likely the most boring piece of reading out there.  So I’m in a place where I’m very comfortable with my debt so I don’t feel I have a lot to say on it.

Yet I realized that fact I can write that statement and mean it could be something worth talking about.  After all we are entering an economic down turn and I’m so relaxed by it all I think I get some people overly nervous by it.  I mean I’m not cutting back on anything.  I’m still spending the same amount at Christmas this year and I know there is almost no way that I’m going to be worried about the bank trying to take my house.  My only real complaint is I wish I had more cash to go spend more money on investments!

The way I think about debt is it is a very interesting breed of dog.  You usually get it when it is small and very manageable and you actually can like the thing.  Yet if you feed it too much it grows and then needs more food to keep growing.  Keep up this for too long and the damn thing eats more than you do and starts to take up so much room it takes over your master bedroom and you can’t get the thing to leave because it’s so big it won’t listen to you anymore.  Yet if you don’t over feed it at all it stays the same cute size and heels on command.

The key to keeping debt under control is to just follow a few simple rules:

  1. Never carry a credit card balance.  Pay the thing off every month.  I know that at times there are exceptions but generally speaking 99.9% of the time you should pay the entire amount off each month.
  2. Skip the store credit card.  If you actually buy so much stuff from one place to need a credit card dedicated to that store you have a shopping problem.  Seek out medical help right after you cut up your store cards.
  3. When paying for your car pay at least 30% in cash.  Actually I would like people to pay cash for the entire amount of their cars, but since a mechanical breakdown can force you into looking for another car earlier than planned some credit is ok.  The trick is to NEVER put more than 70% of the car’s value on credit.  Why 70%?  Because new cars depreciate by about 30% in the first year, so you should never be in a position where your debt is more than your car’s value.  So if you can’t pay that other 30% in cash you likely can’t afford the car you are looking at.  Cars in general to me are the worse black hole out there for money other than debt.  Where else can you buy something new that will lose most of its value in the first five years you own it.
  4. A line of credit is not a cash machine.  It’s not a good idea to use a line of credit other than buying investments that pay more than your interest bill.  Using a line of credit to redo the basement or pay for that vacation means you are not facing the obvious: if you can’t buy it for cash, you can’t afford it.  Try delayed gratification for a change of pace, it might grow on you as a concept.
  5. Never buy up to your maximum pre-approved amount for a mortgage.  The first house we were pre-approved for a maximum of $262,000.  We ended up spending $120,000 and getting a mortgage for $108,000.  Yes, less than half.  Just because you are buying your first home doesn’t mean it should come with granite counter tops and stainless steel appliances in the nicest area in town.  It should likely be a bit of fixer upper and be in a so-so neighbourhood.  One of the biggest mistakes young people make is taking on way more mortgage debt than they should and becoming house poor.  They seem to have forgotten that your home should improve with your earnings, your house should not improve before your earnings improve.

So those are my rules.  Obviously they have worked for me and I’ve broken a few of them myself at times, but I was learning as I go.  So what would you add to this list? Or if you don’t agree with something tell me why.

Comments

7 Responses to “Keeping Debt Small”
  1. jo says:

    I would add if you want a bigger ticket item than save for it.

    I remember reading about a family that wanted to buy a cottage. They found a magazine picture of the kind of little cottage they wanted and put it on the fridge covered by a blank piece of cardstock that had pencil lines drawn into squares on it. Each square in fant represented $1000. Whenever the family had saved another grand, they cut away one of the squares to reveal a little more of the picture. I thought that was a lovely idea. They had a lot of anticipation, joy and satisfaction that way and they happily built their cottage once they had saved the money.

    A person could do the same thing with a vacation, new car, or gadget. A lot of happiness comes from anticipation and delaying gratification.

  2. Ramona says:

    A slight amendment to #3. I put the entire purchase of my car on a loan, due to the VERY low interest rate – it was better to invest my down payment. I then paid the loan off in 3 years. 4-1/2 years later, I still own and drive that car, and plan to for another 4 or 5.

    But I get your point. And I’ve run into trouble with point #4.

  3. Money Minder says:

    I’m with you. I have a debt allergy. Other than our mortgage we are debt free. I wrote a blog this morning about lay-away making a comeback and providing an altenative to carrying debt.

  4. One of the things that helped me retire at age 55 was that after about age 25 I never made a loan for an auto. Even towards the end of my working career I always drove one of the oldest cars in the employee lot. It was sometimes an embarrassment. But hey…those guys are still working in Winnipeg and I’m out paddling etc. Some times I did minor body repairs to hide the rust and on one occassion I even splurged for the cheapest MAKO paint job.

    We always had a designated “savings” account to cover the purchase of the replacement “used car”. $x was automatically transferred from the account the paycheck went into into a special “designated savings” account for such things.

    I still think in those terms but have simplified and done away with the designated account system.

    CM

  5. Northern Investor says:

    I agree completely. A good tip when buying a car is to only buy a car you can afford to finance over three years. Between your downpayment advice and having payments over three years, you shouldn’t go wrong.

  6. Canadian Dream says:

    Ramona,

    Oh, good point. I forgot about those crazy cheap loans you can get with the car dealerships.

    Money Minder,

    Ah, layaway! I remember that. I’ve personally never used it myself, but it’s a good idea.

    CM,

    I could see no car loans saving you a lot over the years. I’ll have to remember that when I need to replace my current car.

    NI,

    Good tip!

    Tim

  7. LifeArtist says:

    A low interest car loan may make sense if you have the money in an SAFE investment that will return more than the interest rate; however, make sure you pay attention to any finance fees that will hurt your return.

    I will also mention that if you need a car NOW and cannot afford to pay cash for a new one, how about used? In fact, used may make more sense even if you can afford new since it has already done most of its depreciating.

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