How reframing how we think about debt can help us avoid it
John Lowe of MoneyDoctors.ie gives invaluable advice on how to reframe how we think about debt, and how this can help avoid falling into debt.
The greatest threat to your financial well-being is borrowing, whether that's in the form of mortgages, personal loans, overdrafts and credit cards. This is because the cost of borrowing money is a huge drain on your most valuable asset: your income, your number one asset.
Borrowing is a necessary step for many individuals, whether it's paying for education, a new car, buying a home or getting through a financially challenging period in your life.
During the course of your life, however, the amount of income you earn will be finite. Once it is gone, it is gone. That is why it is dangerous to spend, as many people do, over €100,000 on paying loan interest.
What’s more, the cost of borrowing can’t just be measured in terms of the interest you are paying. You must also factor in the opportunity cost, the money you would otherwise be making if you were investing your income instead of spending it on servicing your debts.
Let me give you one simple example:
Repaying €10,000 over seven years at an interest rate of 9.9% will require monthly repayments of €165. Total interest cost will be €3,850.
If you invest €165 a month wisely for the same period earning, say, 7% a year (certainly achievable over any medium to long term period on the stock market with professional guidance - this is arguably the best asset class of them all, as over the last 30 years from 1991 to 2020 the average annual growth in the stock market was 10.72%) your capital will be worth €18,398.
Here are some tips for rethinking debt and how to approach it.
Reframing debt
Most people borrow money but fail to think of themselves as being in debt. The fact is:
You don’t have to be in any sort of financial difficulty to be in debt.
When you add up the cost of servicing your debt, including your mortgage or the capital borrowed, it may come to more than you imagine.
Debt is the single greatest threat to your financial freedom and security. It is sucking away your most valuable asset: your income.
The first benefit of being debt-free is that your money becomes your own to spend or invest as you wish.
Not having any debt will make you less vulnerable. You won’t need so much insurance, for instance.
Avoiding certain habits when spending your money will help avoid falling into debt, whether it's being late on your credit card bill or missing a mortgage payment.
Sizing up the problem
Over the last 20 to 30 years, consumer debt has increased at a frightening pace. Why is this? Some borrowing is unavoidable, for instance, loans taken out when ill or unemployed. Some can be attributed to other factors such as changing social values, lack of financial education at school, our consumer society and ‘impulse’ spending.
However, I believe the main reason for borrowing is that ‘debt’ has become a hugely profitable business. Bluntly, some lenders are using clever marketing tricks to ‘push’ debt onto innocent consumers. They are doing this because the returns are irresistible.
Look how much money they can make:
If you leave money in a current account, you’ll typically earn nothing or virtually nothing by way of interest.
That bank, however, can lend your money to someone else at anything up to 22% (€22 for every €100 e.g. credit card rates) a year, incurring huge profits and yielding decent returns for the shareholders.
Although banks are most careful with their cash at this juncture, it isn’t difficult to see why, in general, they fall over themselves to lend money. Or why in the past they have devoted themselves to coming up with new and ingenious ways to sell loans to their customers.
The trick is to avoid the temptation and only borrow when you absolutely have to.
The views expressed here are those of the author and do not represent or reflect the views of RTÉ
For more information, click on John Lowe's profile above or on his website.
