Sunday, October 25, 2009

What is debt?

Debt is a tool.

Let's get this out of the way now. Yes, debt is a tool. It's a vital tool for society. Businesses need it, for certain, and entrepreneurship is the backbone of our society.

Individuals can use debt wisely as well. A student from a poor background can use student loans to attend a college program that opens up the door to earnings that are many times what he would make otherwise. Taking on a reasonable mortgage can mean building equity with your monthly housing expenses rather than spending it on rent that you'll never see again.

Now that we got that out of the way ...

Debt is a dangerous tool

Debt isn't a hammer, where the worst you can do is smash your thumb pretty good. Nor is debt a kitchen appliance, where you'd probably have to put your mind to it to really hurt yourself.

Debt is a power tool. It's a raging chainsaw that can and will do you grievous damage with ordinary use, if that use is not careful and does not follow all of the carefully planned safety guideliens.

You wouldn't walk into a building store, buy a chainsaw, assume you know how to use it, and begin applying it to every problem in your everyday life. Don't do it with debt either.

Debt is indentured servitude

Debt is nothing but the promise to pay money later. And most of us only get money through work, whether it be for an employer or for ourselves. So when you borrow money, you are promising to work a certain amount for that money in the future. And it adds up fast.

The average American household has about $18,500 in debt and makes about $50,000 a year in income. Even before taxes, that debt represents a pledge to work, on average, about 775 hours of work, almost 20 weeks.

The average American household has promised to work for 20 weeks of their future in exchange for money they've already spent, in exchange for nothing new. They will add nothing to their lives or their pocketbooks for that work, they will be working for nothing.

Debt is choosing to pay more

Imagine walking into the grocery store and seeing all the price tags have changed. Eggs are now marked "$1.29 per dozen or $1.89 per dozen." You reach for the milk, and it says "$2.19 per gallon, or $3.29 per gallon." You reach the register and the cashier rings you up. "That will be $149.53, or $215.88. Which would you prefer?"

It seems nonsensical, but people buying consumer items with debt choose the more expensive option every single day. Debt is nothing more than the promise to pay more later than you would have to pay now if you had the money.

The most common way we fool ourselves is that debt usually involves payment. You don't borrow $100 and know that you have to pay $120 in six months. You borrow $100 and promise to pay $20 each month for the next six months. The more complicated the math, the easier it is to not think about the reality of how much you are truly paying.

On a web forum I read, a poster was asking for the advice of which of two cars to choose: A used car with a loan payment of $250 a month for three years, or a new car with a payment of $600 per month for six years. Ignoring the fact that the poster can't really afford either, there was a psychological reason for choosing to think about the cars in those terms. $250 vs. $300 is just $50 per month. It makes them seem as if there was little difference in price. The reality is that the second car would cost $9,000 more. $9,000 seems like a lot of money, $50 does not.

Debt is not necessary, it is a choice

We do have bankruptcy laws for a reason. People who find themselves in dire straits due to, say, unexpected medical bills have a way to discharge them without having their lives and livelihoods ruined. There are no more debtors' prisons.

But otherwise, nobody needs debt. We choose debt. We choose student loans rather than working in high school and college to save up for a small state school. We choose car loans instead of doing without a car until we can afford a cheaper one.

I'm not saying the choice isn't easy. Besides peer pressure, we have an increasingly skilled and complex marketing complex in this country all designed at whipping us up into a consumer frenzy. But it's still a choice.

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