Understanding Debt

When you look at your gas tank, and it's on empty, what feeling does that elicit? If you’re anything like me, you can’t stop thinking about how many miles you have left until you are going to be on the side of the road. There’s a feeling of anxiety, and if nothing else, it is on my mind every mile I drive. 

When it comes to our money, too many people are running on empty. The path I am leading you down is one that establishes a full tank! Once you have completed all 8 steps and maintained them, you will have the confidence that comes with a full tank. 

Just as there are 8 marks on your car’s fuel gauge, there are 8 marks on your financial fuel gauge that, when worked in succession, will bring you that full tank confidence. 

They are: 1 - Balanced Budget; 2 - Give 10%; 3 - New Zero in Checking; 4 - Adequate Insurance; 5 - Consumer Debt Paid Off; 6 - Invest 15%; 7 - New Zero in Savings; 8 - Housing at 25%. 

Today, we pick up with Step 5: Consumer Debt. As you can imagine, we are going to camp out here for a minute because this challenging and often crippling subject has many facets. 

As I broach this emotional topic, I want to begin by being clear. I am neither for nor against debt. Debt is amoral, meaning it is not, in and of itself, categorically moral. Debt can be a destructive evil. It has torn people down and has caused heartache, divorce, and all sorts of strife. Debt has also built churches, businesses, and hospitals that have been used for incredible good. Debt is neither categorically right nor wrong. 

To understand different sorts of debt, we must first understand assets. 

Imagine, for a moment, that you are in your backyard with a shovel. You decide that you’re going to dig a hole big enough for a pool. You begin digging this hole, and beside the hole, you make a pile of the dirt that you’re removing. As you get about halfway through, you realize that you’re no longer going to be able to afford the pool, so you fill the hole back in, and before long, your back yard looks just like it used to. No hole and everything is back to normal. No harm, no foul, right? 

Now imagine the same scenario, but this time, instead of putting the dirt beside the hole, you have a dump truck take it away as you fill it. Again, halfway through digging the hole, you realized you weren’t going to be able to afford the pool. But this time, the dirt is gone. You have a massive hole in your backyard, and you don’t have any dirt to fill it in; you’re stuck. In this scenario, it’s no harm, no foul. You have a massive hole that is not only an eyesore, but it’s a liability. Someone could fall in and hurt themselves. What started as a harmless project has become a massive problem. 

This story shows the difference between asset-backed debt and unsecured debt. 

In the first scenario, the hole you are digging is your mortgage. You are taking a loan out on your home and now have a proverbial hole. But beside the hole is the dirt to fill it in, or the asset that caused the hole in the first place. If, for some reason, you were no longer able to afford that mortgage, you could most often sell the house, your asset, and the hole would be filled in. If the dirt is beside the hole, the hole is a lot less risky. In other words, if your asset, your home, is greater than your mortgage, you’ll have no problem filling in the hole if needed. You’ll be able to sell your asset, pay off your mortgage, and be left with a flat backyard. 

In the second scenario, I am talking about unsecured debt. This sort of debt isn’t secured by an asset; in other words, there’s no dirt to fill back in the hole. This is the person who digs a hole with a credit card. They spend money on that fancy vacation or that nice dinner out. By swiping the card, they are digging a hole. But the dirt is vanishing into thin air. As they look at their credit card balance, they realize they have a substantial hole in their backyard, but there is no dirt beside it to fill it in. This person can’t sell their vacation they've already taken or return the meal they've already eaten. The dirt is gone, and they’re left with a hole that is a liability and a burden. It isn’t going to fill itself, so over the next several years, this person must work to earn more dirt to fill the hole back. This is unsecured debt. 

Now that we have a better understanding of asset-backed debt versus unsecured debt, next week, I am going to begin walking you through standards around mortgages, cars, credit cards, and personal loans. These standards will all stem from the principle of the dirt and the hole, so make sure you read next week in light of this week’s column. 

Money has a purpose, and it is fuel for your journey.

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Zach Santmier is the owner of Trumble Agency, Inc. and the author of the personal financial course, Increase. He focuses on helping families escape paycheck to paycheck living so they can freely pursue their ideal future.