Every now and then, I come across an article or forum post describing debt as a tool. There is a certain amount of risk to debt in the first place, but there are circumstances in which going into debt can be leveraged for gain. However, I would say that debt can be a tool, but not that debt is a tool. I don’t personally like this phrase anyway, but I have some thoughts on all of this, pertaining specifically to paying off a mortgage and then also as applied to things like student loans, etc.
To Pay Off the Mortgage or Not
It’s a common debate in the FIRE community whether to pay a mortgage off early or keep it as long as possible, considering low interest rates and the ability to earn more with that money invested in the stock market.
The latter perspective is actually pretty interesting. If investments average 7-10% in the market, and your mortgage only costs 2%, then it makes sense not to pay off the mortgage early and instead put that money in the market, as you benefit from the 5-8% spread. This probably didn’t make sense when interest rates were at 8%+, but they do now, and have for quite awhile. Many people have done this and it’s worked out well for them. And I think there’s something to be said for not putting all of your extra money into paying the house off, as that money could otherwise be set aside for hard times, such as if you lost your job. Consistency with making payments on a mortgage is extremely important, as certain levels of inconsistency can cause you to lose the entire thing. Now, I had one friend whose mortgage allowed him to pay extra every month and this would reduce how much he needed to pay in the future, such that paying double one month would allow him to not pay anything the next month. That’s maybe not a bad way to “pay ahead”, but I don’t know how common such an arrangement is, as I’m not very familiar with mortgages. I think sometimes guaranteeing future payment is more valuable than paying early, though, if you have to choose between the two.
However, this whole idea of not paying the mortgage off early and relying on the market to outpace your mortgage’s interest rate doesn’t sit well with me. There’s a saying in investing that everybody’s a genius in a bull market, and I think that especially applies here. The market has been on a tear for the past decade. I’m not a doomer who thinks the end is nigh, but bear markets do happen – it’s not a question of if, but when. Just because some people have become fabulously wealthy over the past 10 years doesn’t mean you should assume things won’t change, so this whole idea of holding onto a mortgage and leveraging it to invest in the market sounds like a small house of cards.
Those who pay the mortgage off early are often considered “emotional”. And I’ve read many stories of people who did this and absolutely love owning a paid off house. Those who keep the mortgage and invest their extra money in the market are often considered “rational”, and have been happy to see their money grow significantly.
Which direction you might choose depends on your personality and disposition. But honestly, I get really sick of seeing the rationals beat up on those who pay their houses off for emotional reasons. From a systems perspective, I think paying the house off is actually the more robust of decisions, as it doesn’t rely on external factors (never-ending bull markets, for example), and allows you to effectively eliminate an entire category of expense in your life. But when the market keeps growing for long enough periods of time, humans get this status anxiety where they fear they’ve missed out on something, while their “rational” friends are out making lots of money. “Have fun staying poor!”
The social factor of investing is really interesting. And it’s a shame, but peer pressure in investing is very real. Many people buy houses because there’s social status attached. I talk about this all the time. Who wants to be the person who missed out?
What’s not good is having a mortgage but no other investments. At the very least, you should have an adequate cash cushion to survive a job loss or a major repair to the house. Ideally, you’d have substantial other investments that are more liquid than the house itself, so you can ensure that your equity isn’t threatened by other expenses or emergencies in life.
Leverage works for a lot of people: that doesn’t mean it’s going to work for you. It’s also easy to make money by using leverage during a bull market, but leverage often wipes people out during a bear. This doesn’t mean leverage never makes sense, but I’ll get back to that.
Students Loans, Consumer Debt, etc.
I’ve often heard mortgages and student loans considered “good debt”. Calling anything “good debt” requires a strong constitution, in my opinion. Debt is only as “good” as what it accomplishes; it is not inherently “good” in any other sense.
See, there are many, many things in life that have an upfront cost. Do you want to buy a house? It has an upfront cost. Need a means of personal transportation? Upfront cost. Skills for a particular job? Upfront cost. Want to learn how to work on your car? Upfront cost (for tools). And this is one of the reasons that people with the lowest incomes in society struggle so much: what do you do when you can’t muster the upfront costs? Well, debt becomes an option. Unfortunately, it’s also very risky. If you’re poor, you have no other assets to fall back on. If you’re not poor, you might. So the poor really have to gauge the utility of the debt, and that ultimately determines whether a debt is a tool or not: its utility.
Many years ago, I had an account with Kiva (have I mentioned this before?). For a brief period of time, before I lost interest, I enjoyed making loans to young people in developing nations who were investing in capital, such as equipment for baking, a sewing machine, and tools for an automotive repair business. I enjoyed making these loans because I knew that these things were very likely to increase those individuals’ incomes over time. These people were not taking on debt for consumer goods: they were taking on debt for capital. They maybe already possessed skill, but didn’t have the money for those upfront costs. I wasn’t particularly concerned about getting my money back, but I knew that these were sustainable enterprises and would likely be income-producing and improve those peoples’ lives.
Student loans for academic degrees are interesting. While they are technically a form of intellectual capital, they are not necessarily income-producing. Some degrees confer access to income-producing jobs, while others don’t. I don’t personally have anything against degree that aren’t income-producing – I have one myself! – but these are of course very dangerous for those who take out loans for them. I think my entire generation was failed by the (often left-originating) lies that academic education was worth the price, no matter what, and that a college degree was a doorway to a middle class living. For many, it has become a horrible trap.
On a slightly related note, skills are capital, too, but they are often taught in trade schools, and those have upfront costs just like more-academic degrees (which generally produce less-tangible ‘knowledge’, not to be confused with ‘skill’).
A car loan could technically be considered a capital investment, if it allows you to get to a job and earn money. Car loans are most often taken out for brand new cars, which are only very rarely necessary for getting to work. I’d go so far as to say that most – though certainly not all – car loans are consumer debt, though usually not in the case of the poor or low-income. Also, you don’t need a Lexus to get from point A to point B. Period.
Actually, since I switched to working from home full-time during the pandemic, my car is technically no longer “capital”, as I don’t need it for producing income. This actually means that me knowing how to work on my car is less valuable than it otherwise would be if I absolutely needed my car to get to work. This is very interesting to me.
In short, though, general consumer debt is really NOT a tool.
Concluding Thoughts
I used to be a fan of Dave Ramsey, but I’m really not anymore. He tends to be very draconian when it comes to debt, and has built this inflexible identity around himself that is his “brand”. He has also done some messed up stuff to his workers. And has some odd investing advice, and doesn’t really explore the possibility of saving more than 10-15%. It’s just funny to me when people could easily afford to save more, but don’t. It’s not that you have to, there’s just this weird acceptance in our society that spending is happiness, even though the things purchased often languish in storage. Spending can be fun, no doubt, but the problem of just restricting yourself to saving 10-15%, when you could otherwise save more, is that you end up throwing the rest of the money away, just for the experience of buying things, not because it actually works in your long term interests (for those who happen to have a decent amount of disposable income).
Our entire financial system is a testament to the use of debt as a tool. It can be very dangerous, but it’s also how a lot of small businesses are even capable of being started. I sometimes wonder what the world would look like without any debt, and I actually don’t think it would look as positive as one might want to believe. But you really have to mitigate the risk however you can. Starting a business in an industry you aren’t familiar with is kind of foolish, for example. Sometimes you’re better off not having a degree than being in debt for one that doesn’t give you access to jobs that can pay your student loans off. Etc, etc.
I think one key to understand, though, is that debt is systemically fragile, and is generally best avoided if you don’t specifically need to get past the initial costs of capital, or otherwise have sufficient collateral to repay it. The people who go around saying, boldly, that debt IS a tool, are, I think, dangerous people to listen to. They have usually scored big with debt and are under the illusion of survivorship bias that debt is always a tool and everybody should take it on. This is, of course, something you often see among small-fry real estate moguls: “I leveraged $1,000,000 in real estate and turned it in to $2,000,000! Leverage is awesome, I love it, and if you don’t do the same, you’re missing out!” Having an income-producing investment property is one thing, leveraging more money than you could ever hope to repay for an opportunity at something you really don’t need is something completely different.
Pass. Hard pass.