The basic concept of debt is simple. It’s when someone borrows money from another person. But once we start looking at different forms of debt such as sovereign debt, treasury bonds, mortgage-backed securities, demand loans, etc, it can start to sound like a different language to many of us.
Even the money in your wallet right now is just another form of debt. It may not be your debt but if you trace back that money to its initial point of creation you’d discover who’s debt it belongs to.
Year of the Debt
It has come to my attention that there is a lot of misinformation and confusion about the topic of debt on the internet. That’s why I’m making the proclamation that 2015 will be the year of the debt. I dedicate this year to write more about debt and its impact on our lives. I have even created a new section on the blog that’s all about debt.
Most consumers are told that being in debt will hold them back from spending, investing, and living the life they want. But this is not entirely true.
Canadians now have more debt than ever before yet our average household net worth continues to reach record highs. So debt and wealth doesn’t have to be contradictory. In fact, often times debt can increase our financial well-being.Alberta has the highest household debt of any province, but they also have the highest household incomes.
Consumers love to spend money. And around this time of the year big spenders tend to have a whole lot of purse-onality. A report from the newyorkfed.org shows that Americans have a total of $11.7 trillion of household debt. Roughly 74% of that is mortgage debt. That’s aboot $37,000 of total debt for every man, woman, and child in the U.S.
Meanwhile, a recent report from the Equifax credit bureau reveals that Canadians now carry a total of $1.5 trillion of debt. This is 7.4% more than a year ago. And it works out to be roughly $43,200 per capita. But not to worry because if we remove the mortgage portion, then the total amount of debt has only increased 2.7% from 2013. This is actually quite sustainable, because if the inflation rate is around 2.7% and our debt increases by the same amount then the real value of our debt wouldn’t have gone up at all.
It looks like Canadians are 17% more indebted than Americans. Sorry But stable growth of household debt isn’t necessarily a bad thing. In fact, it’s what’s keeping the Canadian economy competitive. Canadians have to stimulate the economy by consumer borrowing and spending. Low interest rates have encouraged people to do just that. Auto loans showed the most significant increase, at 6.8% year-over-year. This is great news for everyone! Drivers can own new cars with affordable financing. Dealers are making more money from selling more cars. The manufacturing sector is firing on all cylinders. And total economic activity increases across the country. I don’t see any problems with this picture.
A devil’s advocate may suggest that borrowing money to buy expensive cars and speculate in the hot real estate market may not be such a smart idea. But let’s not forget that personal finance is relative. Despite the increase in debt, the delinquency rate — (bills more than 90 days past due) — remains on a downward trend and now stands at just 1.1% of all loans in Canada, Equifax said. In other words people are better off with their debts today than when they had less debt in previous years. That’s because the cost of debt is what determine’s our ability to pay it back. For example I would much rather owe a bank $100 with a 2% interest rate, than owe $80 with a 10% interest rate. Assuming these loans are amortized over many years, the latter loan, despite being a lesser amount, will end up costing me more money.
You know the credit market is tight when the former Chair of the Federal Reserve can’t even refinance his mortgage. If that’s of interest to you, you’re not a loan. Ben Bernanke graduated with a Bachelor of Arts in economics in 1975 from Harvard University. He later received his Ph.D. in economics at The Massachusetts Institute of Technology (MIT.) Bernanke once even taught as a professor at Princeton University. He was also the chairman of the Department of Economics there from 1996 to 2002. But perhaps he is most notably known as serving 2 full terms as chairman of the central bank of the United States. He had control over the monetary policy of the world’s largest reserve currency. In other words he was arguably the most powerful and financially influential person on the planet.
So imagine everyone’s surprise when his request to refinance his mortgage was denied. As the Chair of the FOMC his salary was nearly $200,000 a year. However since he no longer has an impressive W-2 (T4 slip in Canada) he does not meet the requirements anymore of someone with a “stable income.” Nevermind he now makes $200,000 each time he presents a speech. Or that he currently has a $1 million book contract. Or that his net worth is over $2 million. All the bank sees is a person who was working over the last 11 years, and is now unemployed. The metrics by which financial institutions decide who to give loans to is flawed to say the least. Anyway the balance on Ben Bernanke’s mortgage back in 2011 was $672,000. It was a 30 year fixed-rate loan at 4.25% interest rate.
Many financial news sites have already discussed this story. However hardly anyone is talking about the most important question. Does it seem strange that a multi millionaire, who has always made a lot of money, still have a $672,000 mortgage at age 61???
Perhaps it shouldn’t.
The reason why Ben Bernanke likes to stay in debt
My investment strategy has always been to follow what the top 1% of the richest are doing with their money. Ben Bernanke’s behaviour of using leverage is perfectly in line with other like minded individuals.
Here’s why it makes sense to take on debt, even when he could pay off his mortgage at any time if he wanted to. It’s because interest rates are at rock bottom. He printed a lot of money during his position of power that insured rates will continue to stay low for years to come. Every dollar that the Fed creates out of thin air becomes a dollar of DEBT that the United States people have to bear. The only reason the economy is still holding itself together is because the cost to service debt (the interest rate) is low. Rates have been so low for so long that people and government alike have become addicted to cheap money. With a record amount of debt the country simply can’t afford the cost of those debts to increase any time soon.
Ben Bernanke bought his house on Capital Hill in 2004. Today his home has appreciated in value by $126,468, and the stock market has gone up by nearly 100%. This means by using the bank’s money to buy a property he was able to free up his own savings to invest in the profitable stock market.
Plus, by flooding the banks with so much money, Ben Bernanke made sure that the U.S. will have positive inflation. Most people don’t like inflation because it eats away at the value of their savings. But this same reason is precisely why it helps those who have debt. Inflation in the U.S. is currently at 2% a year. This means 2% of Ben’s mortgage balance of $672,000 will be paid off automatically by this time next year. That’s $13,400 of real wealth gain, created passively and discreetly thanks to the monetary policy that he purposefully designed, which is an environment of low interest rates with modest inflation. Inflation is created to help the U.S. government pay down its massive $17.8 Trillion national debt. However it benefits personal debts as well.
Printing money also has the effect of propping up the financial markets because: a.) it creates more financial transactions and activities. And b.) the market needs to build in future inflationary pressure. And using leverage in a rising stock market can multiply the returns! Furthermore. borrowing money to invest means the interest that one pays on the loan is tax deductible.
If Ben had paid for his house in cash (used no debt) then he probably couldn’t have bought one nearly as expensive. A smaller, cheaper home would not have appreciated as much as his actual, larger home did. So he would have missed out on part of that $126,468 tax free gain from his appreciating residence. Not to mention all the stock market gains he would have missed out on too.
In other words Ben has brilliantly engineered the financial system to reward those who use leverage and debt to build up their financial assets. His successor to the Fed, Janet Yellen, is most likely going to continue the monetary policy that Ben had put in place. So far Yellen has done nothing but print even more money on top of the balance sheet that Ben left behind.
We teach kids to not begin a sentence with the word “Because.” We tell them the smallest things in the universe are atoms and molecules. But when the kids grow older they learn about proper grammatical structures and subatomic particles and inevitably realize that the information they were taught as children were simply inaccurate . Popular financial advice like “Don’t carry a balance on your credit card,” can be misleading as well.
One favorable reason to carry credit debt is for investing purposes. Earlier this summer, my pal at Finance Journey updated his June net worth where he had multiple credit cards with a combined balance of $26,800.
Being $26,800 deep in credit card debt may sound like a bad situation to be in, but he was actually leveraging the promotional low interest rates on his credit cards to buy large cap, blue-chip companies that paid him more dividends than the interest he accumulated on his credit card loans.
He’s an average, middle class guy but he’s managed to grow his investment portfolio to about $100,000 in just a couple of years thanks to his modest savings and credit card leverage. Even low risk government bonds will still yield a higher return than the cost of those special credit card rates. If we know for certain that our borrowing cost will be low for a set period of time, and higher returns can be made elsewhere, then we can use the opportunity to make some extra money at virtually no risk
Credit cards can also be used as a bridge loan, for example to cover the cost of buying a new car before selling the old one. It’s a way to use other people’s money at no cost to us. Many people including myself also use credit cards as emergency funds When I received a promotional 1.9% balance transfer last year, I did not hesitate to carry a $5,000 balance for many months. My credit card loan became part of the money used for a down payment.
Simplified financial advice is designed to connect with the most number of people so it tends to be generalized. Believing credit card debt is inherently bad is like believing humans evolved from apes. It’s just a convenient lie we tell kids because their brains are not developed enough to comprehend the real truth. But we’re not kids anymore. We must look at credit cards objectively and make decisions based on facts, and not on stereotypes.
We shouldn’t borrow money just for the sake of having debt, but in some circumstances carrying a controlled amount of credit card debt can be our best option to financial freedom At the end of the day what really matters are results. Crunch the numbers and do whatever makes sense to you.
Random Useless Fact:
Both humans and apes evolved from a common ancestor that lived 5 to 8 million years ago. Given the right conditions, a modern ape species might evolve into something like a human, but it would take millions of years.
I came across a story recently about a couple who moved from Colorado to California. Their incomes doubled and within two years they became debt free The article starts off as follows.
This couple dropped $185K+ of debt in 20 months – Here’s how! What do too many student loans, a mortgage, and a few bad money decisions equal? A debt upwards of $185K. This couple destroyed that debt in twenty months through budgeting, scrimping, and a handy book about personal finance…
Wow, good for them Can you imagine paying down on average $9,250 of your debt every month? That’s amazing! This couple must have sacrificed a lot and lived like paupers to reach debt freedom so quickly.
However what the article introduction doesn’t reveal is that most of their $185,000 debt was in the form of a mortgage, and they sold their house and paid back that mortgage within the 20 month period I tweeted my findings and received some funny replies from the Twitterverse
Sarcasm aside, this is why it’s important to look at changes to overall net worth and not just the debt or assets as individual parts. So here are a few lessons we can learn from this story.
Don’t judge an article by its title. If something seems too good to be true it probably is. According to last year’s poll, virtually every visitor to Freedom 35 Blog has a positive net worth. This means anyone reading this who currently has debt can literally pay it all off and be completely debt free if they wish. All they have to do is sell your assets.
Debt is not a major financial worry if you have a positive net worth. If debt was really stressing you out, you would have sold your assets and paid back all your loans a long time ago. The fact that most people, including myself, have outstanding debts despite having a positive net worth, is evidence that we care more about having our material stuffs than living a debt free lifestyle
The amount of debt someone has is irrelevant in and of itself. For example, having $40,000 of student loan debt and no financial assets is worse than having $400,000 of debt, but also having an equal amount of assets.
Whenever I hear stories about someone paying off a large amount of debt within a short period of time I always take it with a grain of salt
__________________________________ Random Useless Fact:
How to recycle used underwear. #frugal to the extreme. #swag