I love going to the gym. If it wasn’t for the fact that I eat a lot of carbs and fatty foods then perhaps I too would have a chiseled chest and a rock hard 6-pack. If only I had the same resolve about my diet as I do for my dislike of debt, but it’s just so hard to turn down a bag of potato chips. It’s true, sometimes my wants, overcome what’s actually good for me, even though I know before and after the fact it was bad idea. Call it eater’s remorse or whatever you want.
When it comes down to our own personal finances this is often what happens to us. There are so many things that we want. New phones, new cars, new clothes or even new homes. Since society, and the banks, makes it so easy for us to borrow money we do it. Why delay the gratification that we can get now rather than saving money and getting it later? Besides, by next week it might not be cool anymore.
This is probably why the average Canadian debt level has reached a record high of over 164.4% of annual income. The scary part is that it’s still rising. It’s not only young people that have been borrowing money, but seniors have been accumulating more and more debt to pay for retirement. Just to take things in perspective, the debt level is so high, it far exceeds what the US level was at prior to the bursting of the housing market in 2008.
I’ve written many times about cash flow. Why does this heading show up so many times in my posts? It’s quite simple. Cash flow is the life blood of our own personal finances. The basic building blocks of achieving financial independence is all about positive cash flow. We can’t even talk about investing, insurance or even buying things unless we have positive cash flow. It doesn’t matter how much material wealth you have or the amount of money in your bank account. If you don’t have positive cash flow, eventually you’ll find yourself having to sell your belongings or dip into your savings to pay for things.
Having large amounts of debt, especially high interest debt, is the most debilitating thing that you can do to your cash flow. The fact that you have to make interest payments on a monthly basis for carrying the debt means that money can’t be put to use for other things: Dinner out, movies, new clothes, coffees.
The more debt that you accumulate the more crippling it will be to your finances. Since most of your money will go towards paying interest, you won’t have money left over to pay for the things that are a necessity. This facilitates more borrowing. Leading to more debt. Ultimately leading to higher interest payments. It’s not hard to see how someone can fall into a debt spiral that he will never be able to get out of.
“Why pay someone else’s mortgage?”. Well I say, “Why pay the bank interest?” In some of the most popular urban centers in Canada like Vancouver and Toronto, the cost to buy a single detached home has become extremely prohibitive. Even with low interest mortgage rates, the cost to own a home can literally decimate your cash flow. As I wrote in one of my previous articles The Minimum Cost To Live And Own Your Own Place In Toronto, the cash flow needed to own is generally more than renting. You need a higher amount of monthly income in order to own versus rent.
It’s true that owning your own home forces you to make payments to yourself, but the interest cost is also very high. It’s not because interest rates are currently high, that’s far from the truth. It’s that the cost of housing has risen far above average wage increases in popular urban centers. This has led to a general decrease in the cash flow of many individuals who have bought homes. For most people, they will prioritize their mortgage over any other expenditures they may have. Who wouldn’t want to make sure they keep a roof over their head?
One overlooked aspect that doesn’t come into people’s mind about a home is the amount of mortgage that one might undertake. The monthly cost may crimp your cash flow but what about the $750 000 debt that hangs over you for the next 25 years. Though payments could remain low for the next 25 years, how long will it take a couple of earners to pay off that much amount of debt? Even if homeowners are able to pay off $100 000 each year on their mortgage, it would still take over 7 years to pay off the principal. What about the interest costs? That’s not even factored in.
It’s not to say that owning a house isn’t a great idea, but it’s necessary to factor in how all the debt can be managed while still maintaining a standard of living that we’re all accustomed to having. I’m sure all would agree that we weren’t born on this earth just to own a piece of land and have a roof over our heads.
If there is any debt that is worse than credit card debt, it’s probably automobile debt. Owning a vehicle creates a lot of conveniences in life, especially in Canada where everything is so far away, but something always irks me to know that I’m paying an exorbitant cost for something that decreases in value to $0.
Unlike houses, cars don’t appreciate in value. However, unlike other consumables, a car costs a heck of a lot of money. If you want to buy European car prepare to pay even more. The worst part is when the car reaches its end of life the whole process of paying one off starts again. It’s not unfathomable to imagine that you could end up paying more for your cars during your lifetime than your own home. Especially if you’re a self proclaimed car person.
Loans for cars will generally have a shorter time period where the amount has to be paid off. You will never see 25 year car loans like houses because a car will probably not even last that long. This means that the amount that you’ll have to pay is much higher. If you want to jump into a BMW 320i it’ll cost you $700 per month to own for 5 years. That’s a hell of a lot of money to commit to and it will drain your cash flow on a monthly basis. This is why I recommended for young professionals that buying a luxury car is not a good idea.
Keep It Under Control
I’m not going to condemn people for going into debt to purchase the large things in life that they want or require. The most important thing to monitor is that you shouldn’t be gorging on debt to achieve short term wants. That would be a recipe for disaster.
One of the most important things to gauge whether you should take debt or not is to determine how long it would take for you to pay it off. You need to factor in the other things in your budget that you still have to pay for: Food, clothes, entertainment, shelter, etc… After that if you were to put all your resources to pay off the debt how long would it take? Are you going to be under the weight of your debt for many years to come? If you feel uncomfortable knowing that you’ll be paying the debt for a very long time, then perhaps it doesn’t make sense to take it.
Remember that it is more important to be cash flow positive than taking on additional debt that will cripple your finances for years to come. Stay diligent and let your money work for you rather than paying interest to the bank.