Paying down debt is quite satisfying. Having no money can actually be quite addicting and thrilling. Let me explain.
When you have no money, your body’s survival instincts are triggered. Without money, your risk of starvation and being homeless increases. Therefore, you tend to do everything you can to make more money.
Debt puts you into this financial hole that makes you try to get out. With each debt payment, you get a little closer to the surface. The thrill of debt is partially why taking on a mortgage to buy a home is so rewarding.
Debt enables you to buy a nicer home than you can afford with cash. Every time you pay your mortgage, you’re building more equity until you one day own the home outright. Further, the home has the potential to appreciate. No wonder why mortgage is considered the best type of debt to have.
Finding New Ways To Get Into Debt
Currently, I can’t for the life of me figure out what else to spend money on for the rest of the year besides the basic necessities.
I paid for my club membership and a couple new tennis rackets earlier this year. There’s no need to buy a new used car anymore. The last thing I want are more clothes and shoes after going to Goodwill 12 times this year already. Meanwhile, we own a nice home that’s good enough for our family.
For the past couple months, I’ve been mulling over whether to pay off some more vacation property mortgage which costs an expensive 4.125%. It sounds like a good idea since there’s not much left and I have the cash.
The next step was to decide how much to throw at it. I refinanced to a 7/ ARM in 2019 to 2.625%. Obviously, I’m going to pay down my higher mortgage interest rate first.
How Much Debt To Pay Down
After much internal debate, I decided to pay down a $50,000 slug to save $2,000 a year in mortgage interest expense. With barely any cash leftover after ear marking funds to pay for property taxes, charity, and pay for some of my parent’s home remodeling, I’m pretty much tapped out!
Here are some things to think about before deploying all your liquidity to pay down debt or buy that third property.
Decide if there’s anything else left you need to buy.
I racked my brain to come up with bigger ticket items other than the upcoming vacation and property taxes and I couldn’t figure anything out. I don’t want to buy a new or used car to replace Moose, but if I need to, I’ll just save for several months and buy something.
I’ll probably buy some gifts during the holidays and go on another short vacation to Lake Tahoe as well, but all that can be funded from salary.
Decide what would happen if there was an unforeseen large expense.
I don’t believe in an emergency fund as described in my article, “The Emergency Fund Fallacy.” Emergencies are all too frequent, and there’s no point discriminating between certain dollar bills.
Make sure you have insurance for all sorts of accidents, including disability insurance in case you can’t work. You can always decide not to save for a while as you tend to your necessities eg if you save 50% of your after tax income, you have a 50% income buffer for “emergencies.”
Also, identify who in your family can provide you a bridge-loan in case things really hit the fan.
Know what your savings interest rate is and calculate the spread.
My bank savings interest rate on my $50,000 was a measly 0.3%. That’s a pathetic $150 a year in interest! To allow my bank to only pay me $150 a year on interest for that much money kind of makes me sick.
The spread of 3.7% (4% mortgage – 0.3% savings) is HUGE, especially since I like to arbitrage things out when spreads start hitting 2%. As a result, paying down 4% debt is a no-brainer. What is your bank paying you?
Know thyself and your own risk tolerance.
Some expressed worry about the sudden lack of liquidity. When I was working, I saved 100% of every other paycheck (50% of after tax savings). Further, I also have passive income in the forms of interest income, dividend income, and rental income. Finally, I can go teach tennis and flip burgers at McDonald’s for $14/hour if I have to.
Therefore, I’m not worried about suddenly going to a razor thin cash balance. Instead, I get super pumped to work hard to make sure my other income streams are maximized! To me, paying down debt is thrilling because it starves my liquidity. It’ll be a fun goal to save up a good little war chest by the end of the year.
Calculate your asset-to-liability ratio.
Besides using debt to live a better life, you can also use debt to boost your wealth. You just don’t want to get too carried away and take on too much debt.
In 2020+, interest rates have come way down, mainly due to the coronavirus pandemic. The government is aggressively stimulating the economy by unleashing a lot of liquidity. Therefore, the temptation to take on more debt is great.
Make sure you have the appropriate asset-to-liability ratio on you way to financial freedom.
Paying Down Debt Is Great
Every time our backs are to the wall, we find a way to make things better. “Going Broke To Win Big” has been one of my financial tenets for a long time. I love the feeling of having no money because I get so motivated to try and optimize my finances and make more.
Every month, I always pretend I’m poor by starting from scratch. It keeps me on my toes and provides relentless energy. You should try going broke sometime. You might just start loving it!
Paying down debt is great. It gives you a sense of accomplishment. Further, it makes your financial situation stronger. Whenever you have some doubts about what to do with your money, pay down debt. You’ll feel happier each time you do.
Refinance your mortgage to a lower rate. Credible offers some of the lowest refinance rates today because they have a huge network of lenders to pull from. If you’re looking to buy a new home, get a HELOC, or refinance your existing mortgage, consider using Credible to get multiple offer comparisons in a matter of minutes. When banks compete, you win. Mortgage rates are now at ALL-TIME lows!
Refinance your consumer debt. If you have a lot of high interest rate debt, take out a personal loan with a lower interest rate and use that money to pay off higher interest rate debt. Don’t keep revolving credit card or insidious payday loan debt. Credible offers competitive personal loans. Check them out and see what interest rate you can get to consolidate your debt.
This post was originally written on October 17, 2011. During this time period, I was very focused on paying down debt and getting my financial life in order before negotiating a severance. Today, on September 11, 2020, I continue to focus on building wealth and managing debt to lead a better life. Mortgage debt is so cheap now that many people are borrowing to upgrade their homes during the pandemic. Logical move.