Americans believe that debt is normal. We can’t imagine life without our credit cards; go through college without student loans; or get a home without mortgage. Credit and debt have become so intertwined into our lives that we consider it as normal. And like anything else in this world, anyone who does not follow the norm is considered different and treated like an outcast.
This is pretty much how our society treats individuals who believe that debt is bad, that it is something that we can do without, and that we are better off if we wipe our debt slate clean as soon as we possibly can. Those who are for the elimination of their debts are treated as pariahs when in fact it’s the only way towards financial independence. What makes this pill very hard for so many to swallow are the fallacies that have been fed us since day one. Identifying these fallacies about debt is the first step towards gaining a real understanding of the real face of debt.
In the following sections, we will debunk the various fallacies about debt that our society has long believed to be true.
Fallacy 1: Debt is needed to create wealth.
Truth: Debt is risky and cannot make you rich.
For far too long, we have been led to believe that you need to go into debt in order to create wealth, that you need to loan large amounts of money in order to start a business, and that using credit available at our disposal for as long as we pay it back is good. Debt is supposed to be a tool that, when used wisely, will help you reach your dreams. If you are studying business or accounting in the university, your professors pretty much say the same thing. Financial self-help books written by supposed experts in the field also echo the same fallacy over and over again.
Unfortunately, this is not quite right. The truth of the matter is that debt is quite risky and any leverage that you’re supposed to get from it is counterbalanced by this risk. If you apply this to the real world scenario of starting a business, you will immediately know the truth. Let’s say you borrow capital to start your own entrepreneurial venture because your feasibility studies show that your business would click. Unfortunately, when you had finally set up shop and actually started the day-to-day operations, you find out to your dismay that you were just breaking even on some days and losing on most. Not only are you not making a profit, you also have to take care of the payments of your outstanding loan.
Contrast that if you were to start your own business from your own savings. If worse comes to worst, you might lose everything but in the event that you do, you don’t have to worry about paying anyone and getting sued if you don’t. You have only lost your own money and can just “charge it to experience.”
Fallacy 2: Loaning money to friends and relatives is an act of kindness.
Truth: Loaning money to people you love destroys relationships.
First, let’s get one thing straight: Loaning your best friend or your child money is different from giving them money. When you grant them a loan, you expect payment and they look at you as a lender and put you on the same level as that of a bank or any other financial institution they hold loan accounts with. It doesn’t matter if you, out of the kindness of your heart, granted your loved one an interest-free loan or charged very minimal interest. The loan itself changes the nature of your relationship. And this change becomes more evident if your loved one becomes unable to pay the loan.
The most common reaction would be avoidance. They would go to a self-imposed exile out of shame and guilt for not paying you back. There goes your relationship—and all because you thought that granting a loan is an act of kindness.
If you want to help out a loved one, do not grant them a loan. Give you have something to give and expect nothing in return.
Fallacy 3: Cosigning a loved one’s loan is another act of kindness.
Truth: Cosigning a loved one’s loan will almost always mean that you will have to repay it.
We all want to help a relative or a friend in need. But if your sister wants you to cosign a loan she has a hard time applying for, ask yourself why she needs a cosigner. As you may already know, one of the main reasons why lenders ask someone to co-sign a loan is because the borrower has had a history of non-payments. Whether it is just a habit of paying the bills late or something as serious as filing a bankruptcy, an individual’s credit history has already been marred in some way and the bank wants to make sure that someone will pay this person’s debt in case the borrower is unable to.
While it is not good to judge anyone—after all, so many people have rebounded and paid off their debts even when someone cosigned for them—it is perfectly reasonable to assume that there is a good chance that you will end up paying your sister’s loan if she defaults. This can only lead to resentment on your part and again, guilt and shame on the part of your sister—a perfect recipe for broken relationships.
Talk with your loved one and if you can help by giving money then do so. But it’s a bad idea to cosign.
Fallacy 4: Payday loans and other forms of cash loans help those with insufficient income.
Truth: These are examples of predatory lending that do not give any benefits.
If you live from paycheck-to-paycheck and still fall short of cash a week before payday, it is tempting to resort to payday loans. After all, if you just need $300, these types of lenders will give that to you right away for only a small service charge, of say, $30 for example. Then you pay it when your paycheck arrives. However, when you look at the math, you’ll realize that you’re actually paying sky-high interest rate when computed on an annual basis. Compared to the standard APR of credit cards which is pegged at 12 percent, payday loan interest can go anywhere from 400 to 5,000 percent in a year.
But what is worse for most payday loan customers is that resorting to this does not help change their mindset about saving and spending. They believe that since it is there, they don’t have to worry about not making they check last until the next payday. Borrowing also becomes highly addictive for some. They borrow from many different payday loan lenders even for non-essential needs and find out that they are in hot water when they cannot anymore repay these. You do not win with payday loans.
Fallacy 5: It’s perfectly okay to buy your home furnishings and appliances under a financing plan.
Truth: The only way to buy these items is to pay for them in cash.
Many furniture and electronics stores offer financing plans for customers who want to buy a new dining set or a brand new flat screen television but don’t have the money for it yet. Many are easily lured by promos which tout “good as cash” deals if you pay for it in three months or less.
The problem with these offers is that they often come with many hidden charges and conditions. Unless you read the fine print of the contract before you sign, you will most likely be shocked when payment time comes that you are paying more than what the salesperson said you would pay for.
The only way to buy chairs, beds, gadgets, and other similar items is to save for them, ask for a discount, and pay in cold hard cash.
Fallacy 6: Getting a car loan is very acceptable and is a part of life.
Truth: Constantly paying for a car is a waste of money.
We know that cars are a necessity these days. But you have a choice as to the kind of car you will get. You also have a choice as to how often you need to buy a car. Unfortunately, many Americans think that their car needs to be changed every three to five years so that no sooner had they finished paying off their previous car, they’re off shopping around for a new one. This behavior seems to be regarded as “normal” since everyone is doing it. Everyone except those who can actually afford to.
Millionaires and billionaires know that being a slave to car payments is a big waste of wealth. The money you use to pay for the car can be put to your own savings or even invested in the stock market to give you returns in the long-term. Take care of the car that you have already paid in full for and it will still reliably take you anywhere you want to go minus all the payments.
Even if you are offered a zero percent interest on a new car, you’re still throwing away a precious amount of money especially if your old car is still in top condition. Remember that once you drive away with that new car, it immediately starts to depreciate. You’ll never be able to recoup what you paid for it because in the span of five years, you will only be able to sell that car for so much less than what it originally cost you to pay for it.
Instead of getting a new car, investing the monthly payments supposedly intended for that new car is a far better idea. Doing so will bring you closer to your goal of creating wealth and not burden you further with debt that will only bring you to financial ruin. Later on, when you’ve already secured your finances and have money to splurge then you can gift yourself with that set of wheels that you have always wanted—paid for in cash, of course.
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