Bad debt is the debt that borrows from your future. Besides having an emergency fund it is the single most influential thing that prevents Americans from becoming wealthy. Cars, big houses, credit cards, and all forms of bad debt are bad because when one takes out debt to purchase a standard of living above what is affordable. This debt then has interest that works against you – not for you. What really is the cost of this debt?
Current Value of Debt
The average American has $16,240 of non-household debt. While being a large sum of money that indicates Americans are living beyond their means. That debt costs interest. Take debt at 6%, that debt has a cost to the consumer of $974 per year. That is a lot of fancy dinners out or a nice bathroom remodel (I just remodeled my bathroom for less than $800)
Future Value of Debt
The most important component to building wealth is to use compound interest to your own advantage. That is where your money is making you money and that little money makes even more money for you. Einstein called this growth the Eight Wonder of the World.
However, when we collect depreciating assets (or even assets that hold their value) with bad debt, i.e. it costs us interest, we are borrowing from our future rather that investing into our future.
A luxury vehicle typically is $600 a month to lease. That amount of money invested annually for 40 years at 9% interest is $2,651,701.43. That is quite the sum of money for a little luxury! That $2,651,701.43 would generate $106,068 in passive income using the 4% rule. For most people, that is certainly enough to live a great life.
Eliminating this bad debt is so crucial to building yourself up to financial independence but perhaps is the hardest. It takes an honest look at what we really value in life and cutting expensive spending. However, once we trim the fat off we will be leaner and meaner. Both good things as we try to move forward to financial independence. Once we make the cut, we find out that we are more happy and satisfied without the excess.
That money that was going toward depreciating assets but also interest payments can now be used to grow and build income producing assets.
Slamas Llamas 