Living debt free or not

March 1, 2007

I recently read an article on MSN entitled Being debt-free can be costly.

While I can’t argue against any of the specific points it makes; they are good points, I will have to add to what I wrote about my goals about being debt free.

I see there being three ways of living in a debt filled world. The first way, and the most common, is living with lots of debt, in a paycheck-to-paycheck scenario with most income going towards paying debt. The second way is paying off most debt but keeping some major debt, like a mortgage. The third way is to pay off all your debt and living completely debt free.

I haven’t gotten very far in my debt payment plan, but I am aspiring to do the third way. The article from MSN, however, recommends the second way, recommending to float cheap debt, to keep an active credit score and/or investing the difference at a higher interest rate to pocket the difference.

I am not going to refute the logic in the second way, except to say that in my mind, it is optimistic thinking. While I know that it is possible for me to get ahead with this plan, I’d rather play it safe and get rid of my debt and not end up owing something, should an unhappy market decide to turn my investments against me.

The article mentions several cases of people who got burned when they needed credit because they lived without debt for so long that their credit score fell. When I read some of the cases in the article, I wonder where these people were putting their extra money, and so because of that, I wish to state several things that separate the second and the third financial plans.

The article says that creditors view people with no credit score / no credit history as just slightly less risky then the people with actual bad credit. This is probably because creditors are around to make money off of you. If you have a credit score that says that you don’t like having debt, the chances are high that you will pay off your debt early, and the creditor will make less money from servicing your loan. Would you invest in something that has a track record of making more money or less? So in theory, option two would sound reasonable to keep you looking good to creditors.

What about option three? If you pick it, know that it will very likely damage your ability to get credit due to you not looking good to creditors. Am I worried about not being able to get credit? No. I feel that many of these cases failed because they didn’t have a plan to stay debt free after becoming debt free. If you decide to pick option three, you should have a plan to keep from needing debt again, and then with that plan, you can then finally break free from the worry that your credit score matters.

What that means that you need to save before you spend, and by save, I don’t mean saving on a case-by-case basis of wants, but initially save like you are still paying off debt. The first milestone should be saving enough to get you away from living paycheck-to-paycheck by having between a three to six month cash buffer for emergencies. But instead of stopping there, to save to the point that you would be able to purchase the most expensive thing you might want in the future for cash. I don’t mean that you should sacrifice all conveniences in life to accumulate cash, but keep things in balance so you don’t end up sabotaging yourself in the long run.

For me the most expensive thing in my future would be a house purchase (or a newer house purchase than the one I currently have) and so I am planning on saving the majority of my money until I could easily afford a house in the market that I am living (in addition to six months of reserves).

But what if you for some reason, end up needing credit before you get to the having saved enough. My suggestion, and I hope any readers of mine will correct me if I am wrong in this theory, would be to present the loan in a way that makes it looks good to a creditor.

The article mentions a guy wanting to borrow to purchase a house and include some extra money in the loan to renovate it. The guy was wanting to put a little under 50% down. I don’t know if this would have changed the scenario, but it probably would have worked in his favor to keep the $25k he was estimating for the renovations, and present $15k as a down payment for a 15 year mortgage. Sure he could easily pay the loan off in less time, but it makes it appear to the lender that he isn’t planning on it, and so while his interest rate may not be as great as it could be, he would be able to get the loan from a conventional source, since about 25% is more reasonable, and from what I understand, construction/renovation loans are more strict and less widely available than standard mortgages are. He could then pay it off early if he should choose to.

The thing to watch for with any long-term debt, such as mortgages, is if it contains “pre-payment penalties.” These penalties are imposed either if the debt is paid off early, or if too much is paid ahead during a specific period of time (usually during the period of a year). My current mortgage has a three year prepayment penalty period, so if I end up paying too much extra during any of the first three years of the loan, I get charged extra (due to lost potential interest during the life of the loan). After three years, the pre-payment penalty period expires and I am free to pay down the debt as fast a possible.

So what do you think of my thoughts and/or strategies?



  1. What Are Your Options If You Have Bad Credit?

    Excellent site for the Living debt free or not. You can get more
    details about a home, personal, student, small business and other
    loans even if credit history is poor!

    bad credit

  2. Thank you addhu for this comment, and for this somewhat relevant website for those who might have unfortunately ended up with bad credit or a bad credit score.


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