Part 5: DEBT FREE - Financial Independence Series
24 Mar, 2024
Get out of debt. Stay out of debt.
I think of debt as a phase of life I moved through. That period has passed, and I’ve moved on. Jonny and I have now been entirely debt-free since our early 30s, and I encourage you to head down the debt-free path as well.
Debt has always had an ‘ick’ factor for me, a feeling I am grateful for. I like earning interest, but I hate paying it.
When I was in my early twenties, each time I went into debt, it was under the advice of others. A good friend encouraged me to lay-by (the 90’s equivalent of BNPL) a piece of art. My Dad encouraged me to take out student loans. Both meant well. They thought using OPM (other people's money) was an obvious solution.
But the ick factor for both of those decisions was high. In fact, a day after I made my first payment on the piece of art, I returned and paid it off in full. Two years into university, I hated seeing my rising student loan balance (due to the interest charged) and my bank overdraft, so I paused my studies to work full-time. I returned two years later, paid my student loan in full, and cash flowed the next three years of study, graduating with a BSc in psychology and a Graduate Diploma in management. I was a better student for having done so. I had removed the financial burden I felt, had grown up a lot, and had gained invaluable workplace experience.
When Jonny and I decided to buy a home together, we signed up for the most significant debt: a mortgage. I was 27. Interestingly, the ick factor was reduced. Why? Unlike the debts I’d had in the past, I knew we couldn’t afford to save up and pay cash for a house, and debt could help me buy a home. On the advice of our bank, settling into a 30-year mortgage was the normal thing to do. But one year in, I felt uneasy again. I compared the money we earned with the money we paid on our mortgage and couldn’t wrap my head around paying for my house until I was 57. What a ridiculous idea! So, we got after it, upped our mortgage payments, threw lump sums at it, and paid off our home in just five years. Knowing what I know now, we could have paid it off much faster.
Despite our bank trying to lure us back into debt to buy a rental property, there has never been a day that I/we regretted becoming permanently debt-free. We never have to seek the bank's opinion about our financial decisions again.
Note.
Before I get into it, I know some people are in debt due to factors beyond their control. While I hope this blog post helps, it’s not written specifically for them. Having answered thousands of questions over the years, I know a much greater cohort of people have made questionable decisions that have led them directly into debt. It’s no one's fault but their own.
This is for you.
Good debt. Bad debt.
For the record, I don’t subscribe to the idea of ‘good debt, bad debt’. It’s all just money that you owe someone else. And trying to justify your debt positively by calling it ‘good debt’ is just pulling the wool over your own eyes. Don’t do that.
When you take on debt, you actively decide to give up a portion of all future pay cheques to service it. This may be for a finite period, or it may become indefinite.
For example, in my podcast episode #91, Grace told me she put her $500 haircut on a 10-week payment plan, forgoing $50 of her take-home pay each week to pay off her debt.
A recent graduate I know is earning $130,000 a year, but she forgoes $250 a week to pay back her $90,000 student loan. She will continue to make this payment for the next seven years.
Most people with mortgages go back into debt as they constantly borrow to upgrade their whare or upsize.
Borrowing money has long-term consequences for growing your wealth. And it is increasingly common that we don’t have just one payment sucking the life out of our take-home pay; we have multiple. It’s not hard to find a university graduate with all three debts mentioned above: BNPL, student loan and a mortgage.
In each phase of life, those who think that debt is perfectly normal start to collect a few of them. Inevitably, one day, life happens, and the chickens come home to roost. Something upsets the delicate balance of their income, offsetting the debt they have to service.
That is when most people begin to feel the burden of debt, which invites risk into their lives.
Plan to stay out of debt in the first place
Avoid going into debt in the first place.
Ignore the common refrain that you “have to go into debt”. It is not true.
I’ve discussed this in Part 2: Budget. Sinking funds are your ticket to staying out of debt in the first place. The same rules apply whether you are my daughter (16) and just starting out or a 55-year-old reading this. Save for the item you know you will buy and pay cash.
No excuses.
If you have enough lead in time, most debt, with a mortgage being a possible exception, can be avoided. Jonny asked me if I could have avoided taking out student loans. The answer was no because I never even realised an alternative existed. I was told that I had to take on debt to study. As a parent, I won’t let my precious daughter wander unquestioningly into debt as I once did.
Learn to budget, not “handle debt”.
Don’t teach your children to ‘handle debt’
It’s not good for them.
I know plenty of parents who agree to lend money to their teen to buy a car. It feels very organised as they set up a weekly repayment plan, and the teen heads off to their part-time job each week to generate the coin to pay their parents back. Inevitably, before long, the car fails its WOF and needs repairs. Unfortunately, their parent's wise teachings didn’t extend to guiding them to have money set aside for these expenses, so payments to Mum and Dad pause while the teen pays the mechanic. A common scenario nowadays is that the repairs are paid for using BNPL. So now, great job, Mum and Dad, your child now has two debts. Handle that!
Instead of teaching your children that debt is an ‘inevitable’ part of life, teach them to budget. Teach them that building wealth is an inevitable part of life.
The world has changed in the last ten years. The ease with which you can wander into debt is astounding; if you don’t coach your children to avoid debt, they will fall right into it. Car loans are rapidly replacing parent loans. BNPL and credit cards will pay for most other things. Debt is a slippery slope.
Too late? Are you already in debt?
You may be reading this and be in debt. That's no problem; getting out of debt can start right now.
The very first step is to stop borrowing more money. Yep, it is that easy. But I’m often surprised when someone says they are struggling with debt and want to get out of it, and my big idea to stop taking out any more is met with silence—and then a ‘but’.
But we have a trip planned, and I was going to put it on my credit card.
But I promised my parents I would fly to visit them and I was going to BNPL.
But I got an interest-free credit card, so it’s not really debt.
No more! It’s all just money you owe someone else.
The definition of insanity is continuing to do the same thing yet expecting different results. If you are sick of debt, immediately stop taking on more.
Are you in debt but feeling pretty comfortable?
To be honest, if you are comfortable and in debt, I don’t think this particular blog post will help you. You don’t believe you have a problem, and there is no sense of urgency to become debt-free. You’ll likely see my ideas as naive.
You have to feel that anxiety in your stomach when an invoice arrives and you are unsure how you will pay for it. You need to feel a little sick when your credit card statement arrives and you spent more than you realised. Or when your beloved pet needs the vet, and for the first time, you sign up for a BNPL and know you are doing it because you don’t have the cash to pay. Or if your company announces a restructuring and your income is suddenly on the line, and you know there are no reserves to pay your future bills. You need to feel that foreboding when the news headlines say mortgage rates are about to rise again.
If you are comfortably in debt, you’ll buy that new car instead of paying off your mortgage. You’ll receive an inheritance and go on a trip worldwide instead of wiping your debts clean and buying your freedom. You’ll borrow against your house to remodel your kitchen. On and on it goes.
Until you feel a little bit ick, everything stays the same.
But ask yourself, where is the personal growth? Where is the big-picture thinking for your life?
Is this really all you see for yourself, constantly handing over a portion of every paycheque to pay for the things you bought last month, last year, last decade and last century?
What if your working life was spent planning for your future instead of paying off everything you did in your past?
When you focus on making the monthly payments, how can you focus on gaining financial freedom and growing your net worth? How will you ever reach a point where you can decide what you want to do without considering a lender's point of view?
Your reliance on your paycheque to service your debt repayments adds an element of risk to your life that I don’t think you are seeing right now. It majorly limits your opportunities.
I have no interest in mortgage interest rates.
When interest rates were ‘historically low,’ I was delighted for those I knew who were firmly on a ‘get out of debt’ adventure. Low mortgage interest rates meant that more of their monthly payment went to paying off the principal of their mortgage. Boy of boy, did they make hay while the sun was shining!
Conversely, others saw this as a huge opportunity to borrow MORE money because the debt was apparently ‘cheap’.
I recall thinking that the constant use of the words ‘historically low’ could only mean one thing: mortgage rates would likely increase. And so they have. Those who took it as an opportunity to smash debt are now winning, while those who saw it as the chance to leverage up had unwittingly invited an element into their lives that they are currently not enjoying: risk.
When you borrow money, you invite risk into your life, and your lender has a say over you.
My husband, Jonny, doesn’t have much to say on this blog, but he often says that he wishes people could feel what it is like not to have debt. Freedom is a word he frequently uses. Our income comes in, we pay our regular bills (rates, electricity, and what have you), and the rest is OURS to do with what we like. That’s financial freedom, and it feels great.
Whatever your debt of choice, pay it off FAST!
Student loans, credit cards, car loans, family loans, buy now pay later, your mortgage, etc.
It’s all debt—money you borrowed, and every day of your life, you will be handing over your income to pay it back and all of the interest you have been charged.
List your debt balances from smallest to biggest, irrespective of interest rates. Now you know what you are facing.
For example, if you have consumer debts:
BNPL - $200
Family loan - $300
Credit Card - $3,000
Student loan - $20,000
TOTAL: $23,500
Make minimum payments and stay current on all of them except the smallest debt ($200). With that smallest debt, pay it off as fast as you possibly can. Get upset about it! Sell stuff (potentially including the item that caused the debt in the first place), work harder, slash your living costs, make more money, and pay it off quickly. Then move on to the next one. Believe it or not, I actually meet many people who enjoy this process. They feel invigorated by the fact that they have taken charge of their money and are taking action.
It’s called the Debt Snowball method of becoming debt-free, and I think it is the most effective. It's ironic that people ‘fight back’ against the debt snowball method with the logic that you should pay your higher-interest debt first. These are the same people who have spent years happily paying interest on their debt! If you approach the Debt Snowball with a fighting attitude, you will be debt-free much faster than you think, irrespective of interest rates!
If your smallest debt is $200, as above, make additional payments as fast as possible until it's gone. Then, move on to your next smallest debt, the $300 family loan you are paying off. Take the payments you were putting towards the jeans, and now put those payments towards your family loan. Hit it hard, using all your income that you can spare until it's gone.
Because you are budgeting now, you will know exactly how much income you have to spare to pay off debt.
As quickly as possible, move through your list of debts, working from the smallest balance to the largest, paying each off in full before moving to the next one. Keep making progress until you are done, and then cut off your access to that type of lending (send marketing emails to junk, unsubscribe to websites and cut up credit cards). Follow this link for more information on the Debt Snowball.
You will pay off these smaller ones FAST, motivating you to keep going. Things will slow down once you hit the big ones, such as student loans and mortgages. This will take years in many cases, and it's a long grind to the finish line. Whereas these smaller debts can be aggressively paid off, creating a more sustainable and longer-term plan for your bigger debts is essential. But the effort and the journey are worth it, and I’m in touch with many people who have spent years clearing debt. The emails I receive and conversations with people who have become debt-free for the first time are some of the most motivating I will ever hear.
I did it. They did it. I see no reason why you can’t, too.
Debt consolidation. No thanks.
If you have several smaller debts with varying interest rates, it can be tempting to consolidate or combine them into one debt. Often, people roll these debts onto their mortgage.
I’m not a fan.
Why?
Because you didn’t pay off any debt. It might have felt like you did something (researched options, contacted lenders and filled out paperwork), but in all honesty, you simply moved it somewhere else. Changing your spending behaviours and feeling the pain of taking your earned income and putting it towards your debt is one of the best ways to stop you from returning to debt.
A thought on housing debt
I feel sick at the very thought of my daughter having to take on a mortgage of the size that many are signing up for these days. Goodness knows what the price of housing will be if/when she decides to buy one. Sitting on the sidelines and watching the increase in the size of mortgages as Kiwis sell the same houses to each other is one of the key reasons I put so much effort into teaching her how to save and invest outside of housing. Hopefully, she can buy her own home one day, but if she can’t or doesn’t want to, the income she can draw from her share investments will be able to cover her rent. As it stands today, Jonny and I can’t afford to gift her money towards a house deposit, but since her birth, we have given her the gift of small investments into ETF funds that could become the start of her house deposit or her rent payment.
Did you buy too much house? Is having a home at all costs worth it? Is giving 30+ years of your working life worth it? I’m staggered at some mortgages people sign up for these days to stay in a particular location. I’m in favour of moving cities to buy a more affordable home. That is what we did, moving from Wellington to Christchurch to buy our first home.
We didn’t just buy a house; we found ourselves new and interesting careers and made plenty of new friends. However, the Christchurch earthquakes saw our debt-free status under serious threat when our property was red-zoned and our land acquired by the government, meaning we were forced to move. Due to supply and demand, Christchurch house prices rocketed, and house quality sank like a rock. We would have to spend more money to buy a worse house, so we moved to a different region with cheaper housing, Central Otago.
I know your town, city, or region has things that make you want to stay. I’m saying there is no harm in looking elsewhere to get ahead. Whatever decision you make has pros and cons. When you take on a mortgage, you must have an end date in your calendar. That should be your goal because, currently, in some cities in New Zealand, mortgages have no end in sight.
Give yourself a pay rise.
When you make your final payment towards your debt, whether smaller consumer debts or bigger ones like a student loan, business loan, or mortgage, you give yourself an immediate pay rise. For example, when the final payment is made on the student loan I mentioned earlier, that’s a $250 weekly or $13,000 annual pay rise that this ex-student will be enjoying.
Becoming debt-free lets you breathe. You suddenly have additional income coming in that can protect you from drama. You will find it far easier to cash flow the things you want to do, and you can quickly increase the amount of money you invest for retirement or financial independence. Even early retirement suddenly becomes a genuine option.
What if I am wrong about debt?
I asked myself and Jonny many times in the early stages of our FI journey: "What if I’m wrong? What if becoming debt-free was a wasted opportunity to leverage our money to build wealth?
We could just take out more debt, buy a heavily leveraged rental property, and find out.
But you know that we never did. And we never would.
I think I’m right about getting out of debt. Our lives are better for having done so, and it has removed a thick layer of stress.
Since becoming debt-free, we have massively reduced our risk exposure, and that has helped us navigate life’s dramas.
We used a credit card, a ‘debt card’ if you will, to avoid using our money to pay for the stuff we purchased, but that didn’t lead us to grow wealth. Once I calculated the annual fees, the fact that you spend more when you use credit, and the hassle factor of budgeting when using credit cards, it left us worse off.
We’ve never gone near car loans (despite salespeople's efforts), BNPL, or any other high-interest forms of short-term lending simply because we got good at tracking our net worth, budgeting our income and expenses, having money set aside for emergencies, and paying into our retirement. We make enough to run our own lives and grow our wealth, and we don’t need to borrow money to prop us up.
When a risky event does occur, such as losing our entire house in a natural disaster in 2011, our discussions were between us and our insurer. It was a relief to know that as we tried to save our home, no lender knocked on our door, keen to hear how ‘their’ asset was faring.
Rising mortgage interest rates have had no impact on us.
When I wanted to stay home with my baby until she started school, I didn’t have to consider that my student loan payments would stop. Because I no longer had a loan.
Our debt-free life has given us the freedom to work the jobs we want when we want. We get to live in the house we want, in the region we want. We can travel and be generous, and the most significant gift is that we have a large degree of freedom over how we spend our time. Being debt-free has given us a level of immunity from the world around us.
Debt was a phase of life for us, and it should also be for you. Use it to your advantage, pay it off and move on with life. Get out of debt and stay out of debt.
Next, I will share the final instalment in my series, which is about learning about investing and earning interest instead of paying it.
