The mind is its own place, and in itself can make a heaven of hell, a hell of heaven. – John Milton; Paradise Lost
So earlier this week I stepped in it a bit when I posted an ad on Kijiji that dared to tell people my mission is life is to help them get out of debt. [See previous post here]. The over-all consensus I learned from most people is the debt is just a fact of life you have to use credit cards and borrow in order to get anything done. You need money to make money, etc.
I’m sorry to say it, but that couldn’t be more wrong.
What’s the big deal with carrying a little debt? You ask. Everybody has some debt, right? Maybe so, but that doesn’t make it right or a good idea. As my mom one asked, “I all your friends were going to jump off a bridge, would you?”
The point is that debt always has a cost and apart from the obvious interest charges the biggest cost to carrying debt is in lost opportunities.
I have a friend who recently came back from vacation and told me that she now has over $30,000 in debt on her line of credit. She and her family had a wonderful summer vacation and made some fantastic memories but at the end of the day they have nothing tangible to show for it.
That line of credit has an annual interest rate of 5%, or $1500 per year. Now because it’s a floating line there is no set time frame that she has to pay it off but if she decided to treat it like a conventional 5 year loan the monthly payment would be approximately $625 per month.
My friend’s son is starting high school next week. In four years he will be getting ready to go off to college and to date she has saved nothing for his education. A four year degree in Canada now costs on average $25,392 not including housing and other living expenses. In order to save that amount of money in the next four years, assuming a 6% return on investments my friend has to start putting away approximately $515 per month.
Now, in order to pay off her debt and put her son through school, my friend has to spend over $1000 per month. She simply can’t afford that and keep her lifestyle where she wants it.
Her thinking is actually to pay the minimum amount on her line of credit, which is about $250 per month so that she can focus on saving for her son’s education. In the short term that would save her about $400 per month but in the end extend her debt from 5 years to over 20 and end up costing over $60,000 to pay off $30,000.
Now consider this.
If she were to cut back her lifestyle a bit and accelerate the debt repayment to $1000 per month she would be out of debt in about 2 years and save nearly half of the interest charges. She could then turn around and put that same $1000 into her son’s education and still have it fully funded by the time he is ready. She could be out of debt and have a fully funded education fund for her son in just 4 years! That’s a full 16 years sooner than she would have been debt free using her own scenario. If she were to then invest that $1000 per month in her own savings plan for the next 16 years she could amass a staggering $680,000!
The bottom line is this. Her plan to take 20 years to pay off her line of credit will cost her nearly three quarters of a million dollars in lost opportunities! She thinks she has to do it this way in order to give her son a future but a more likely scenario is that by staying in debt she is actually showing him a president that will bankrupt his future.
The opportunity cost of staying in debt is just too great. Get out of debt before you become a character in an epic poem by John Milton!