Ep.8 - Why is Debt a Time Machine?

What is Debt?

The word "debt" is all too familiar to the millennial crowd. But what is it exactly? 

Debt is borrowed money you have to pay back in the future

For most millennials, the four main types of debt are student loans, car payments, credit card payments, and possibly mortgage bills. You may think you are borrowing from the government, credit card companies or mortgage lenders, because you make payments to them.  But you are WRONG!  In reality, you are borrowing from your future self ! 

Wait...What? and Why? Because debt is a time machine. 


Debt is A Time Machine

A time machine creates a temporal shift, allowing you to travel between the present and the future. Just like a time machine, debt also creates a temporal shift with money, allowing you to make your future self poorer, in exchange to make your present self richer.  

For example, you buy a $20k car with $5k down TODAY, and you finance the rest with a loan. Let's say a 5-year loan on a 4% interest. GREAT! The moment you signed the papers, you just made your future self poorer for the NEXT 5 YEARS, by exactly $276 a month. Since there's a 4% compound interest,  you will end up paying $16,575 instead of $15,000 at the end of the fifth years. You see, you are not escaping the payment, you are just delaying it and paying the penalty along the way.  If you have to remember one thing, your future self deals with the consequences of a decision you make today. 


You Are Borrowing From Yourself, and You Are Stuck Paying for It eventually

You can purchase anything you want, with borrowed money. But at the end of the day, you are the one who's stuck paying it back, just at a later time. You are not escaping it.  The only thing debt allows you to do, is to consume something today that you may not be able to afford otherwise.


Why Borrow At All?

You shouldn't borrow 99.9% of the time, because debt is bad, really bad.  In my opinion, debt can only be constructive in one of the two following scenarios.

First, debt is good for consumption smoothing in case of a true emergency, such as a car breakdown or a medical emergency. We all experience peaks and valleys in our finances, often times unexpected. Debt is a good way to cover one-off emergency expenses you can't avoid.

Second, debt could be (key word, could!) good for investment purposes. If you can borrow $10,000 at a reasonable interest and grow to $20,000, it is a good debt.

Millennial Common Debt

Four Common Types of Debt For Millennials

Student Loan:  Not all education is worth the cost. A student loan needs to meet two requirements, in order to be considered good debt. First, it needs to increase your quality of life. Secondly, the amount of debt needs to be justified by the increase in your income post-graduation. My personal rule of thumb is, if you can pay back your debt within 5 years from the increase of your income,  it's a good debt to take on. 

Credit Card Debt: It is NEVER good to carry a balance. You should always pay in full. I do think using it to earn perks could be very beneficial.

If you do have a lot of credit card debt you can't pay off all at once, you should consider consolidate them into one with a lower interest rate, that's less than 10%. There are a number of services out there, such as Avant, Prosper, SoFi, the Lending Club, and etc. I have only used Prosper myself, but if you want to learn which one fits your need the best, Review.com has a great article (link) on breaking down the differences, so you can make an educated decision on the best choice for yourself.  

Car Loan:  99% of the time, it is a bad debt, especially when you buy a luxury car with debt. Once I heard the saying, if you have to ask for the price, you can't afford it. It applies to cars. However, if you buy a truck, and use it to make money for work, it could be potentially considered good debt.

Mortgage:  Most people see mortgage as a form of good debt. I don't. Mortgage is bad debt, unless it can generate a cash flow or you can make a profit when selling it. People love seeing their homes' value appreciate. But the secret is, you have to sell it to realize the profit. If you never sell it and think you're $100,000 richer because of the house, you need to wake up from your fantasy. That's phantom cash. It is not real. 



Next Episode

In the next episode, we are going to discuss a common problem for millennials with immigrant parents - financially supporting your parents. If you are one, are you stressed over it? Come back next Friday to check out the new episode!

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