Large Amounts of Debt Isn’t Normal
A quick look at why people think it is
Figureheads in the Finance Industry
One of the first personal finance personalities that I ever started take advice from and study was Dave Ramsey. The man is good at what he does. He is a crusader against debt that has gained some major traction with young generations. Ramsey is against all forms of debt, whether consumer, student loans, or mortgages. This message has resonated with an over-leveraged millennial generation.
The next big personality that I started to read and listen to was Robert Kiyosaki of Rich Dad, Poor Dad. Some of his overarching ideals on money are solid and takes from time-tested finance fundamentals. For example, he advocates for paying yourself first and buying assets instead of liabilities.
However, some of his advice is questionable at best: he suggests leveraging large amounts of debt to get into real estate and putting large capital into small-cap stocks. The danger comes in the nonchalant-ness that Kiyosaki has in his advice. He makes it sound so easy: just take out a loan, buy a few houses, invest in a few IPO’s, and become the rich dad that you were meant to be.
As expected, Kiyosaki is often criticized by those with a background in finance or even those that have some practical, real-life experience. Yet, to many of the “uninitiated”, the Rich Dad method is seen as the method to start accruing wealth.
It doesn’t take much research or foresight to see how taking out large amounts of debts is a recipe for disaster, though. Any event that can lead to unpaid bills induces a large amount of stress. If bills stay delinquent for an extended period, the consequences can be even more severe. As expected, Robert Kiyosaki is generally viewed as a crummy financial guru to follow since he advocates for ultra-high-risk financial behavior in the form of leveraging huge amounts of debt.
The prophecy is self-fulfilling: Kiyosaki’s company declared bankruptcy due to being unable to afford a settlement for unpaid royalties. The exact method of building wealth that the Rich Dad preached caused his company’s demise.
Debt is not without purpose, though. Proper use of debt as a tool without over-leveraging your position can allow normal people to complete milestone purchases, such as real estate. Even Dave Ramsey, the warrior against debt, advocates for taking out a mortgage as long as the debt is small and will be paid off quickly.
Yet, there is a student loan crisis, consumer debt is at an all-time high, and, with the global pandemic causing issues abound, people are starting to feel the pain associated with being burdened with debt. The bull market of the last 11 years has led a lot of people to take on debt pain-free. However, with the economic downturn looming like a gray storm cloud, issues are starting to arise.
It doesn’t take clairvoyance to recognize that debt is, in general, a bad thing. Yet, the American population is still buried in debt. How is this?
The Most Marketed Product in History
The financial industry is established on making money.
Over some time, it was determined that one of the best ways that they make money is through lending money and then collecting interest. It’s the same ideal that many people subscribe to today: instead of having their money sit idly, it’s much better to invest those dollars. Charging interest on loans provides a great return-on-investment. Even if the borrower allows the loan to default, there’s more than likely collateral in place to protect the lender.
To find proof of this, there’s no need to look very far: almost every company that involves purchases or money has some sort of credit line available. The companies will make a huge return on the money they loan out, meaning that those credit lines are a great investment. Not only will there be profit from the actual selling of the item, but then there will be additional money earned from the interest of the loan. Typically, a department store credit card will charge over twenty percent interest. For comparison, the average return from the stock market is seven percent per year.
Obviously, being charged a large amount of interest isn’t for the consumer’s benefit. So why is it so commonplace?
“It’s normal”
The financial industry has spent large amounts of money on perpetuating the standard that everyone must take on debt to buy a car, a house, and other milestone purchases. Through some clever marketing, ample crowds of consumers have been led to believe that debt is even a good thing and will take on multitudes by accruing expensive possessions.
In truth, acquisition of debt is so ingrained in the American lifestyle that if a person were to go against the grain, such as Dave Ramsey suggests, they’ll often be criticized by their peers.
For the sake of example, one only needs to watch commercials. Almost every company that offers big purchases, such as Ford, peddles their deals and tries to encourage taking a loan to buy their product. Of course, they have to sell their product; however, the clever marketing techniques makes it appear as if the consumer has the advantage by using debt.
How are Large Amounts of Debt Accumulated?
Despite the normalization of accruing debt, almost no one plans on over-leveraging and borrowing large amounts of money. Typically, the milestone purchases make up a large portion, but as smaller amounts begin amassing, this ratio can quickly change.
Credit cards
A common story is running short on the monthly budget and using a credit card. Although this may be a saving grace for one month, over time this will add significantly to the problem. The interest on credit cards is incredibly high and can exasperate budget issues over time.
Another is the college student who uses credit cards for daily expenses. Of course, this adds up extremely quickly.
Both examples above are commonplace, and typically, the use of a credit card is seen as normal, or even encouraged. Yet, over a short period of time, combined with the high-interest rates of credit cards, a considerable amount of debt can accumulate.
Student loans
Attending a prestigious school is a great opportunity for anyone that gets the chance. Yet, those schools don’t come without a hefty price tag. A great example of this is MIT, one of the best technology institutes in the world. The education that one would receive attending MIT would be unparalleled; however, the average cost per year to attend is around $50,000.
The fear of passing up such an opportunity pressures many people into taking out loans to attend these institutions. Over several years, this will lead to hundreds of thousands of dollars in debt. Nevertheless, many students still flock to these schools. Even worse, problems from student loans are only becoming more prevalent as the price of tuition continues to rise.
Milestone purchases
According to Experian, the average car payment is around $400 per month. This large monthly price tag is a large risk factor by itself. However, add on to this a large mortgage payment combined with the debts gathered from the methods mentioned above, and it’s very easy to see how one can become over-leveraged by following the typical American lifestyle.
Lower Risk by Paying Off Debt
For overall financial health, a great move is to start eliminating debt. Not only will this free up money to be allocated towards other wealth-building or leisure but will also eliminate a good portion of risk.
Each month consider how a good portion of hard-earned money is given to the meat grinder that is the financial industry. Essentially, by cutting out monthly bills, this money is freed and can be set aside for other activities.
For somewhat of an in-depth analysis of paying off debt, look at this:
Outside of freeing up money, the risk factor is much lower when there is little debt. An event that would be catastrophic while being over-leveraged can be a slight annoyance with no bills and an emergency fund in place.
Despite what the world says about debt and credit, taking on vast amounts brings on risk that, no matter the situation, is never a good idea.
