To Pay Or Not To Pay


I would not pre-pay. I would invest instead and let the investments cover it.”  –  Dave Ramsey


Debt-Free Living has become a thing. A very big thing.

I first began running into the debt-free philosophy 10 or 15 years ago. Since then, I’ve met more and more people who adhere to this way of life. Several of them, if not most of them, have become our clients.

In my conversations with debt-free adherents, one thing has become very clear to me. Each adherent is absolutely certain that he will ultimately find himself in a better financial position by following the debt-free philosophy.

Unfortunately for them, basic mathematics says they are wrong.


What makes a good leverage financier? One who can effectively control debts and do not allow the debts to control him...”  –  Zeng Han Jun


Before we discuss the subject of debt-free living, a lifestyle which many people religiously follow, we need to clarify a few points. We need to clarify that there is good debt & bad debt aka smart debt & dumb debt.

Dumb Debt is debt used to acquire anything which depreciates in value. This means that the thing acquired goes down in value.

For example, purchase a new laptop, then walk out on the street and sell it 1 year later. It’s the exact same laptop. It’s even in the original unopened box and you have a receipt proving that it is only 1 year old. It doesn’t matter. You’d be very lucky if someone, anyone, was willing to pay you 50% of what you paid for it. That’s depreciation.

What would that laptop be worth if you had removed it from the box and used it for 1 year before trying to sell it? You’d be especially lucky if anyone was willing to pay you more than 10% of what you paid for it. In reality, you probably wouldn’t find a buyer at any price.

You knew the laptop would go down in value, but you had to have it. If you paid cash, your loss is only what you paid. If you financed, your loss was magnified by the amount of interest you paid.




 $     3,000

Interest Rate



36 Months

Monthly Payment

 $     91.27

Total Interest

 $   285.57

True Cost



In this example, your true loss is $3,285.57. By financing, your loss becomes 9.5% greater than if you had paid cash for the laptop!

So Dumb Debt is debt used to purchase anything that goes down in value; ATV’s, RV’s, campers, boats, jet skis, jewelry, electronics, furniture, clothing, etc … The Mother of Dumb Debt is financing the purchase of something that doesn’t even exist (services); meals, movies, concert tickets, vacations, and other services.

Given most people do not pay-off their credit cards monthly, and an endless stream of research says that they don’t, people are paying for services years after the service was consumed. Would you have really gone out to eat if you knew you would still be paying for that meal 2 years later? Would you have really ordered that steak if you knew that with interest, it was going to cost you 1.5x more than the price on the menu?

Think about the dumb purchases people make on credit. Take note that most everything you thought of was a consumer purchase … an unnecessary consumer purchase. One of the dumbest financial moves a person can make is to use credit for the unnecessary purchase of a depreciating asset.

On the other hand, Smart Debt is just the opposite. Smart Debt is debt used to purchase an appreciating asset. This means that the thing acquired goes up in value.

What are assets that can appreciate? How about a primary residence? Most people can’t afford to write a check for the price of a house, so they purchase it on credit. Shelter is a necessity of life, so they live in that house for several years before selling it for more than the original purchase price.

So when we talk about debt, I am in perfect agreement with Debt-Free Living advocates when it comes to Dumb Debt; Depreciating assets and services should be paid for with cash. Where we disagree is the use of Smart Debt and that is what we need to discuss.


Financial leverage is the advantage the rich have over the poor and middle class.”  –  Robert Kiyosaki


When I visit with Debt-Free Living believers, I’m usually told something along the line of; “When I get out of debt, I can invest all the money that was going towards payments. I’ll end up with as much as, maybe even more, than if I’d made a payment and invested the difference.” I always listen with a smile while silently thinking that there is no way that will happen. The math is against you. Let’s take a quick look at the math.


Assume we have 2 couple’s. Both have $2,000 per month available to pay for housing and/or invest. When investing, each earns an annual return of 8%.

Couple A believes in financing the purchase of a home for 30 years and investing the difference in their 401(k)’s.

Couple B are Debt-Free Living adherents who believe in paying off their home as quickly as possible before beginning a serious investment regimen.

Let’s see what their situations look like after 30 years.


Couple A

Couple B


 $    250,000

 $  250,000

Interest Rate




360 Months

180 Months

Monthly Payment

 $   1,193.54

 $ 1,849.22

Extra Monthly Payment

 $               –

 $    150.78

Monthly Investment x 360 Months

 $      806.46

 $ 2,000.00

House Value After 30 Years

 $    589,141

 $  589,141

Investment Value After 30 Years

 $ 1,210,027

 $  818,150


Amazingly enough, even though Couple B paid off their home 16.5 years earlier than Couple A, their houses are worth the exact same amount of money. Paying off a debt early does not increase the ultimate value of an asset.

However, our Debt-Free Living advocates have an investment account that is noticeably smaller than Couple A, who financed their home for 30 years and invested the difference.

In fact, Couple B’s account is only 2/3 the size of Couple A’s account. Couple B must add a whopping $391,877 to their account to catch up with Couple A. Either that or immediately earn a profit of 48%!

For our purposes, we kept this illustration very simple. It does not include many other benefits that accrue to Couple A, but not to Couple B.


  • Couple B will lose their Mortgage Interest Deduction after 13.5 years. The result is that they will probably lose the ability to itemize deductions. The end result is that they will pay higher income taxes, just as they are moving into their high income earning years, while Couple A continues to enjoy itemizing deductions and the lower tax rates that come with it.


  • Couple B only enjoyed their 401(k) Contribution deduction for 16.5 years, while Couple A used the deduction for 30 years. The end result is that Couple B paid substantially more income taxes than Couple A.


  • Couple B forfeited 13.5 years of employer matching on their 401(k) contributions. Couple A took advantage of 30 years of employer matching on their contributions.


If the numbers are calculated including these 3 factors, Couple A is so far ahead of Couple B that, short of a winning lottery ticket or receiving a large inheritance, Couple B will never catch-up in their lifetime.

Debt-Free Living is very popular and those who practice Debt-Free Living tend to be full converts who truly believe they will be better off and therefor faithfully pay-off debt as quickly as possible. Unfortunately for them, they have been sold a fad that is no more helpful than a bottle of snake oil.


BUT … There are some key components to managing debt wisely. Anyone who takes on debt without following these tried and true rules could easily find themselves on a sinking ship.

Rainy Day Fund – aka Cash Savings. Those who use debt must have cash savings readily available to pay for emergencies. Most Financial Advisors recommend 6 months budget as your target balance, but that’s just a rule of thumb. The truth is that if you become disabled and unable to work, you need enough cash to take care of your family until your long-term disability policy begins paying. That may or may not be 6 months.

Smart Debt Only – do not carry any Dumb Debt. If you use your credit card for purchases, pay it in full every month.

28% &  36% – aka Debt Ratios. Your housing expense should never be more than 28% of your income. Housing expense includes mortgage payments, property tax payments, and homeowners insurance premiums. The total of all outgoing debt payments should never be more than 36% of your income. Debt payments are just that; mortgages, vehicles payments, student loan payments, minimum credit card payments, etc …

Term – match your repayment term to the useful life of the asset being purchased. Real estate has a useful life of about 30 years before major maintenance is required. Vehicles have a useful life of about 5 years before major maintenance is required (ever wonder why your vehicle warranty is 60 months?).

Interest Rates – do not agree to high interest rates. Interest rates are relative to current economic conditions and must be considered as such. You should only accept interest rates that are average or less for current economic conditions.

Large Purchases – do not carry any Dumb Debt. Pay cash for all of your purchases, including vehicles (vehicles are depreciating assets). This means knowing what you will purchase, when you will purchase it, and sticking to a saving regimen so the cash is available when it is time to make the purchase. I am a realist and understand that most everyone starts adult life with no money & a lot of needs. We have to finance a lot of purchases, especially vehicles. But, if you stick to a savings regimen, when it is time to purchase a new vehicle, your trade-in value + savings, should allow you to make the purchase for cash somewhere around your 3rd vehicle purchase.


Debt-Free Living is not all it’s touted to be. The math is very clear on that subject. The prudent use of debt is oftentimes, if not most times, a better course of action. But Debt Management requires self-control and financial discipline. If you lack either, Debt-Free Living may be the better alternative for you. Just understand that there is a very steep price to pay.


Sapiat Asset Management is an independent registered investment advisor, specializing in financial planning based, asset management for Gen X Individuals & Families and their Trusts & Businesses.

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