One of the things I’ve come to realize over the last year is that in most cases, debt is horrible thing. Granted, many businesses look towards debt as a way to fund capital purchases in their beginning stages, and I have no problem with small business loans. But all the other debt that people are addicted to is ultimately bad for the economy in general.
There are many people who believe that the reason housing prices are skyrocketing in North America, as well as education costs, is due to the availability of cheap credit. I’m one of those people. Stated another way, housing and education costs would be forced to come down if people couldn’t take out massive loans in order to fund them. It seems almost self-evident if you think about it – a product or a service that people can’t afford to pay for must eventually come down in cost.
I’ve read a lot of books that talk about debt, but one stated the net effect of debt in a very elegant way.
Debt means you have to work a lot harder to obtain the same things in life.
A Canadian mortgage is a good example. Let’s say you took out a 35 year, $300,000 mortgage. By the time you’ve finished paying it off, you’ve probably paid close to a million dollars in combined principal and interest payments. So while you now own a $300,000 asset (let’s assume it hasn’t significantly appreciated just for the sake of simplicity), you’ve spent an extra $700,000 to acquire it. That basically means you had to work 3.3 times as hard for that asset – stated another way, it’s almost like for every day of your life you worked and got paid for it, you put in an extra 2.3 days and worked for free. Doesn’t sound like a good deal, does it?
That extra money doesn’t really help the economy – it simply helps bank profits. It would be far better if that money were invested, or saved, or handed down to the next generation.
I want to contrast that hypothetical (but relevant example) with the situation in Buenos Aires. A typical 1 bedroom apartment here costs around $50,000 USD. Granted, the city isn’t as luxurious as it once was, but it’s still called the Paris of South America, and it’s still one of the top ten destinations to visit in the world (as ranked by Time this last year). So why does a one bedroom apartment in a city of approximately ten million people only cost $50,000?
Simple, there are no mortgages. That means everyone has to pay with cash.
That changes things, obviously. For example, many people have to save most of their lives to afford a house. But when they do have the money, they pay for the house in cash and own it outright. Most kids tend to live with their parents until they are in their early thirties, which helps them save money, get an education, and help out around the house.
I’ve been thinking more and more over the last few years that if I buy a house, I’d like to ultimately buy it outright. I don’t know the future, so who knows, maybe in the next few years I’ll have a mortgage like everyone else. But I’m quite content to continue renting until the point in the future, obviously years and years away, when I can simply buy a house without a mortgage. It doesn’t happen very often, but saving hundreds of thousands of dollars simply by waiting doesn’t seem like such a huge sacrifice, especially if that’s money I can use to help my future family out with.
While I may end up back in Vancouver next year, it’s not lost on me that I can just continue traveling, bouncing from place to place for a few months at a time, leveraging the fact that the Canadian dollar simply buys more things in different parts of the world. By renting an apartment in Serbia for a few months, I can save almost $800 a month in rent compared to back in Canada. Even if I factor in the flight, I’m still saving $1400 or so. In fact, other than the expensive side-trips I’m going to take here and there (for example, Machu Piccu), I suspect in the end that I’ll have saved money on my traveling adventures, at least to living the same lifestyle back home.
I am young and haven’t done very much research on home ownershipa t all so bear with me, but:
The way it seems to me is that renting is almost always worse than owning. I realize that with a mortgage you end up paying excessively in interest, but at least the principal becomes equity. When renting, the money you are paying goes into the hands of your landlord. When financing, at least that money is still yours at the end of the day.
So in the end I think it depends on the state of the market and your interest rates… unless you’re ultimately going to be paying more than $1200 a month in interest (or the value of your home will be $1200 times X # of months your spent paying for it, less, later), it makes more sense to have a mortgage, no?
It really depends, but it’s not as clear cut as people think. For example, if you have a $1200 a month mortgage payment, $900 of that could be interest at the start. Plus, you also have property tax, strata fees (for most places in Vancouver), and maintenance costs (replacing appliances, city fees, yardwork, repairs). Suddenly that $1200 a month is more like $1800 if you factor all of that in, and your net worth is only increasing at $300 a month. Unless interest rates are rock bottom or your house is appreciating 3 or 4% a year, renting is comparable (that is, it’s possible to increase one’s net worth at the same rate in most scenarios).
As a renter, you’re not tied down to a particular location. If you suddenly get a job offer in another part of the world or another city, you can give one month’s notice and move on. Often the sale of a house can take six months or more, and you’re stuck with $10k – $20k worth of closing costs, and often commission on top of that. Renters don’t have to deal with any of that.
I’m not bashing home owners – having roots and a place to call your own are great things. I just think it’s less and less wise to finance that dream with huge mortgages these days, especially the younger generation, many of which opted for 35 or 40 year mortgages with only 5% down (and in those cases, were forced to pay probably $8k – $10k in insurance costs due to the high risk mortgage). Most families would be far better off to save a larger down payment and purchase a house later in life.
Anytime the Government step in and “subsidize” an industry, it creates inflation. Health care, education and CMHC backed loans are all examples of this.
If they stopped “insuring” mortgages, and kept interest rates at a higher level, all of the risk would rest on the banks shoulders. People would need a larger down payment to qualify. Home prices would adjust. Same goes for student loans and the cost of higher education.
There are some arguments on the finance side that debt also carries a very strong to keep management in line in the corporate world. Having to pay off debt holders reduces the amount of perks that management in large successful companies can use.
Bank profits are also not entirely bad; many people’s retirement savings and other investments benefit greatly from those profits.
That all said, I hate debt too. Beyond auto financing (when it’s ridiculously low as it has been for the last decade) and my mortgage I’ve luckily never had debt. Living beyond one’s true means is crazy (and those means should include saving for the future!).
Ooops… first line should have read “…a very strong ability to keep…”
Duane,
I recently used a bit of your writing as a form of guideline for a commentary essay that I had written for a composition course. I would just like to state that I myself agree with you that debt is a bad thing–in all ways though! While I do agree that debt is a large reason that economic failure is rampant within the world economy, it honestly is not due, as much as you would think, to cheap credit availability. It is actually a direct result that the entire financial system is debt based. When a bank dulls out the money for a mortgage, or even small business loans, they are never really dulling out any money that holds any value. Lets use a deposit of $30,000 into a bank. That bank instantly puts that deposit towards their minimum reserve, and earmarks that $15,000 of that is available as public lines of credit. While this $30,000 remains in their reserve, lets say you or I go to take out a loan or mortgage. The bank never actually hands any cash to us–or the seller. They hand out a promissory note that states they will eventually cover this debt with cash. This happens not only in private dealings, but also is the same method used with governments obtain money from a central banking establishment for purpose of circulation. As you can see this makes the current definition of “debt” an issue that can, if the current path is continued upon, not be escaped.
I believe you are describing fractional reserve banking, which definitely occurs. Even if they were to hand over cash though, that’s really just a promissory note as well. I often ask people why there are no armed guards in most banks (at least in Canada) anymore. The reason is that most banks don’t really have any money, it’s all electronic. Sure they keep cash on hand for deposits and withdrawals, but nothing substantial. I once tried to withdrawal $6,000 in cash for a car loan and the bank almost wasn’t able to handle the request.
In order to continue to grow the economy, many countries have resorted to using leverage to multiply the growth rate. The problem with leverage is that it amplifies both gains and losses. We saw the latter during the financial crisis of 2008 and 2009, and we’ll undoubtedly see it again soon. They are basically growing the economy at the expense of future growth, since at some point people and institutions will not be able to take on any more debt. That is occurring already, and people have stopped spending and instead started to pay off loans. This may result in deflation, which the government is absolutely frightened of. But in my mind it’s the natural result of people and businesses spending money they didn’t have at the time. Sure there was growth, but it was mostly just on paper.