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Friday, December 15, 2006

Save VS Borrowing: Why Borrowing Is Stupid

(image from 1st Tennessee) One responder to my post the other day (on 0% credit cards) left this message,

I have to disagree with the premise and the following statement "don't spend (or invest) money you don't have."

The average home costs $170k in the US. Should someone not buy a home because they don't have 170k in cash?

Should a high school graduate forgo college because he doesn't have 30k for tuition & books?

Should you forgo medical treatment (even though you might die) because you don't have 10k for medical treatment?

The whole "don't spend money you don't have" sounds pretty stupid when you start putting things into context.


The short answer to this person is yes, and while his comment saying that the idea of not spending more then you have is stupid, is in fact well stupid. However, the poster is using the mindset of most Americans. Americans who will never be wealthy, because they want everything now, rather then following the advice of those who actually have money, like Warren buffet, Dave Ramsey or John Cummuta.

The key is to save for those big purchases, such as a house. John Cummuta even suggests you may have to borrow to buy your first house. However, what you do is buy a smaller house (a starter house) save up money as you pay off that house, then when the time comes to move into a $170k + house, you pay cash for it. The thing is when you borrow to pay for anything, you end up paying much more for it. For example over the course of 30 years you will end up paying the bank a half million dollars for that 170k house. How stupid is that? Why not save the money up and pay less. That is in fact how rich get rich and the richer get richer.
Take a look at Donald Trump, a great businessman, but a poor example of wealth building. How many times has he filed bankruptcy now?


Now for education, this is a common problem, but if a student graduating high school had truly wise and prudent parents, then they would have money saved up for their kids education. Dave Ramsey tells a story about a couple who had a few thousand saved for their first kids education. Now she was pregnant with a 2ND child and wondering how they were going to pay for the education of that 2ND child, who wasn't even born yet. Dave didn't have an answer, probably only be able to pay half of each child's education. That wasn't good enough for this couple, they returned to Dave a few months later and reported that the young father (a school teacher) had gotten a 2ND job over the previous few months, delivering pizza, to earn enough money to fund the newborn education.

These parents were wise, and they thought ahead enough, to even get a 2ND job, to make sure their kids future was met. So Mr. Rich Slick, if you want to really have enough money to be a "rich slick" then you will save rather then borrow and live within your means.

In fact the graph on this post (from 1st Tennessee) shows how much more a borrower will spend on education then a person who had saved. Rich Slick is that what you want for your kids? Sorry, but I want to provide better for my kids future then that.


this article has made it's way into other blogs. Mandy commented on D's post
I guess you mean to take the advice with a grain of salt. Aim high. Some people feel that if there's a loan on offer for 95% of the purchasing price, they should take it. Or if they can get student loans for their kids' entire education, they should go for it.

I think the aim should be to have as much of your own cash as possible. Get the smaller house if needs be, and pay it off earlier. Then it's an asset.

Plan for your kids' education instead of letting it sneak up on you (and them). If you have something to contribute, the debt incurred will be significantly less.

To me, it's all about an attitude adjustment from the "I want it all now" to "I want what is possible without huge debt"
It has also made it's way to GetRichSlick.
Posted by Kevin Surbaugh at 12/15/2006 07:03:00 AM
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13 comments:

  1. How much MORE money will a person with a college education make vs. one without a college education?

    145k vs 65k in college costs is PEANUTS when you compare the fact that a person with a college degree will earn (on average) 55k vs. 33k

    http://www.forbes.com/2003/07/28/cx_dd_0728mondaymatch.html

    55k x 20 years = 1.1 million
    33k x 20 years = 660,000

    By NOT borrowing and going to college you've essentially made a dumb financial move and lost $440,000. Even factoring the loan of 165k (with interest of 35k) you've still made 220k less than a college graduate.

    I can make a similar argument with housing, home appreciation, leveraged debt and interest rates but somehow I think it will escape you so I don't see the point.

    By the way, for the record, I am already rich. I'm trying to become Super Rich.
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  2. Hmm, starter condos in Boston suburbs (where I lived a year ago) where about $275K. It was more if you wanted to live within 15 miles of Boston. In my new place, San Mateo County, CA, the starting one-bedroom is around $350K. So I don't know how it's possible to get a starter house to move into a 170K "real house". Maybe if you live in Kansas it's possible. If my parents had this philosophy though, they'd have missed out on hundreds of thousands in appreciation.

    My brother tried to do it a bit, and even living at home with parents, he couldn't save much more than 25K a year. Of course the housing market was making the cheapest housing rise at 10-15K so he was really making 10-15K a year towards goal. It would take him 20 years at that rate.

    I also don't feel it's the parents responsibilty for college education. It can be, but that's a personal choice that many people make. What if your parents didn't make that decision?

    My fiancee's family is pretty poor (you can read about it at my site), and she had to stretch to pay for own college. As a pharmacist now, she makes a lot more than she ever could without a degree. And that's 40+ years of big incomes. Oh and as a member of the military she'll have a reliable pension and cheap healthcare for life.

    It comes down to realizing the difference between good and bad debt. Mortgages are typically good debt it's tax deductible and it's considered an appreciating investment.

    Education is also considered good debt, because at the end of the day, your most important asset is yourself. It also typically leads to bigger incomes which leave more money for saving.

    I think I'd rather be a Rich Slick than having to take 2nd jobs as a pizza delivery man because I didn't get enough education to make that income from one job.
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  3. Rich you don't seem to understand. I or no one is saying not to go to college...just pay for it ahead. Those that pay cash for everything will be far ahead of anyone that borrows.
    The Jones (the Hare) borrow and shoot out ahead of Joe 6-pack (the turtle), however Joe 6-pack scrapes and saves (like our grandparents) and pays cash for everything. In the long run, Joe 6-pack has more syuff because s/he didn't have to pay all the interet rates. It is the classic story of the rabbit and the hare, I don't know how to get that point through to you.
    You say you are rich, I doubt it, because the truely rich don't like calling attention to theirselves like that.

    Lazy I agree big cities and the coasts in particular is more expensive. I was simply using the numbers that thi detractor was using. The point is still the same, start small and then move bigger when you can pay cash for it.
    As for 2nd job, even educated people (as the couple Dave Ramsey refers to in my post) have to take 2nd jobs for a time to make sure they are debtfree. I think the savings was only $2,000/baby to pay for college education 18 years late. Think what could be done with that savings in your retirement if one or both kids got lucky enough to get scholarships for college, instead of mom and das savings.
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  4. oh one more thing Lazy, if it's not the parents responsibility, then whose is it? The childs? So are they to start work when they are 2? We need to learn to live like our grandparents rather then our parents. Save rather then borrow...our grandparents, for those younger then me great-grandparents knew how to save and pay cash...they never even heard of credit cards.
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  5. "Rich you don't seem to understand. I or no one is saying not to go to college...just pay for it ahead"

    If I had to wait until I had the money to go to college it would have taken me 10 to 12 years to save up enough money. My parents helped a little but I wasn't about to put a burden on them for me since they had already sacrificed so much.

    So I DO understand, I took out student loans, received some federal aid and went to school. I ultimately ended up working part time to help make ends meet. Each time I applied for the next level up in my career I was told that I needed a college degree to move onto the next level. Upon completing my college degree, I finally had a great deal more opportunities opened to me because of it. My total income went for 20k a year to 200k a year all because I went to college using borrowed money.

    As for being rich, when you compare yourself to 90% of the world population, anyone in the US (even a minimum wage worker) is far richer than they think or acknowledge. What is your definition of rich?
    ReplyDelete
  6. Dave Ramsey FanDec 16, 2006 03:14 PM
    Rich Slick, Kevin is right on this..financial guru Dave Ramsey is explicit on this point, and Kevin is only following his teachings.
    ReplyDelete
  7. Well I guess that settles it....if Dave Ramsey says it is so then it must be -so let it be written, so let it be done.

    Don't worship at the alter of the FICO score but do worship at the Dave Ramsey alter.....
    ReplyDelete
  8. Obviously, I don't expect the child to start work at 2 to pay for their own college. The reason why you can't put the responsibility on the parents is that not all parents are that responsible. So my fiancée should have just given up when her parents didn't save for her? Take a job at 7-11? She's one of the top pharmacists in the military today. This was because she took reasonable financial aid.

    I'm going to save for my children's college, but not everyone will. I haven't decided how much I'll pay. I suspect it will be some kind of split. The reason is that I didn't appreciate college as much as I would have if I were footing the bill (I did get a scholarship). My fiancée was never late and never missed a class though, because it was coming out of her own pocket. So I'd like to instill this work ethic, while still not putting my children in mountain of debt.

    I am confused as to why you'd bring up grandparents and credit cards. It's like you suggest that all debt is the same. It's simply not true and that's what is being missed here. I'd be happy to take a 1M debt at 1%, put it in a high interest bank account and collect 30K a year in interest. That's good debt. However, taking that 1M at 10% gives means that I'd be losing 100K a year unless I have some kind of investment that can do better than 10% after taxes (which I don't). That's bad debt.

    Working two jobs isn't always the answer. There's something to be said about being home and having time with the family. Our grandparents lived in a different world where one parent could work 30-35 hours a week and provide a decent living. Nowadays it's more likely that it takes two people working 80-90 hours a week (combined). I don't think a 2nd job on top of that is the answer.

    I don't really know this Dave Ramsey, but if he isn't teaching the difference between good and bad debt I'm not sure I want to. If he's against all debt, it seems as if he doesn't want to educate people to think for themselves about their finances, but instead wants to just dictate what to do.
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  9. Lazy -
    Actually Ramsey teaches people to think for theirselves financially, and not follow everyone else blindly by going into debt.

    The idea is the plan ahead and build your savings so that you can build wealth. As John Cummuta says, do you want to retire and eat alpo and crackers? or would you rather be prudent and plan ahead to as Dave Ramsey says, "live like no one else now, so you can live like no one else (in the future)."

    Finally, when you are broke and debt there is one place to go, to work! there is no lazy way to get out of debt. No one is wanting anyone to work 2 jobs forver, just for a time in combination with cutting out all unneccessary spending, so that we can become debt-free and build that emergency savings.

    Then when we can afford it, start investing in high yeild mutual funds (avoid single stocks as too risky). When you are ready to invest, do your research and as I said invest in the best futual funds....there are funds out there with great track records of consistant 17%+ returns.
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  10. I'm looking at your net worth posting and you don't seem way ahead... Not that I have borrowed huge amounts of money, just strategically when it makes sense...
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  11. who the hell gets a 100k education?

    mainly, doctors, dentists and lawyers - all of whom will make enough to pay it back when they graduate.

    others who have rich parents also get 100k educations.

    I paid for my wife's education. total bill for 2 yrs of undergrad and 2 yrs of grad was less than 20k.

    don't believe the popular press's numbers about 100k education. Anyone can get decent affordable education.

    Plus education and home loans are tax deductible. sometimes it makes more sense to get a loan, even if you can pay cash.
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  12. I know this is old, but it is an interesting way of looking at things. A good starting point (financial responsibility is great), but too rigid for my tastes.

    I graduated high school and my parents didn't have any money saved for college. This isn't my fault, and at 18, I was responsible for my own life. Can't blame the parents, they did what they could. I got some scholarship money, but I still couldn't afford to pay out of pocket, so I took the loans. Most were subsidized so interest didn't start until I graduated. Even in this case, you seem to say, "wait until you can afford it"

    I would have wasted years working at low paying jobs saving a couple grand each year until I could afford to go get a degree.

    Instead, I did well, worked part time and summers, got a internships, splulged on a semester abroad, and graduated about 25k in debt. With a great job offer of 56k a year + bonus and benefits and a career instead of a job. Sure, I'm paying a whopping 4% on my loans now with tax deductable income... but I still say it was the smartest thing I ever did. Financially, and I had a lot of great life experiences.

    Just a perspective.
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  13. In suggesting this the following I risk being labeled as a horribly sexist piggish brute, but I've seen and known about a million families who have incurred massive debt because both the husband and wife (before they get married, of course) go to college, load on the debt and then get released into the wild working world and then 4 years later the wife has kids and maybe goes back to work 12 years later when the kids are old enough to be at school. Meanwhile, they've been working ridiculously hard not having time for anything or anybody not even the kids they are supposedly working for and the wife's debt is piling up as much as the husband's debt is but he's the only one working since she's at home with the kids or the kids are in day care and her salary barely pays the day care costs. Then the kids are old enough to go to college and the parents haven't paid off their own debt yet. Then the parents are working harder because they are stressed about their retirement because social security is just about bankrupt at this point. Might I suggest that not everybody goes to college? Or we go to state schools that cost a mere fraction of the cost of private colleges? Might I also suggest socialism where you pay about 10% more per year in taxes but college/health care/retirement is all included in your yearly taxes? Socialism has MANY issues but let's admit especially in view of the recent TOTAL economic collapse that capitalism and taking on massive debt in hopes that your future might be "richer" has enough problems of its own.
    ReplyDelete

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