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Personal Finance Rule #1

1 July 2011 44 Comments

We’re going to go through a list of personal finance rules that I believe are necessary to get ahead financially. Some of these may not necessarily be in line with what we’re taught generally, but hey, most people are terrible with money, so let’s not get too worried about that.  Today is rule #1.

Rule #1 – Don’t borrow money to fund expenses

There are some clear areas here that are pretty much undebatable and others that are very debatable.  Let’s start with the areas that are clear.

Tons of people borrow money to fund expenses such as lifestyle (namely credit card debt) and cars (auto loans).  Both are terrible decisions financially.  Your lifestyle and your automobile you drive are nothing more than expenses.  One brings pleasure and one is more of a necessity (but can also bring pleasure), but regardless, they are both expenses.

These expenses should 100% be funded with cash that you have.  Using debt means you are paying much more than the actual cost of the expense.  You’re paying for the expense and you’re paying the interest on the debt.

Now, let’s get to the gray area: housing.

Unfortunately, housing has gotten a bad reputation.  That reputation is that it is an asset.  It’s not if it is your residence.  You require shelter thus you incur an expense.  It’s the same whether or not you rent or own.  Wall Street has gone to great lengths to push home ownership as a way to get wealthy, labeled it an “American Dream”, and convinced the public that home ownership is required to make it in life.  This idea of the American Dream has nothing but secure decades of continuous cash flows to Wall Street and the financial sector in the name of mortgage payments.

Thankfully, the recent housing crash has reminded people that homes are not guaranteed assets that will only go up in value.  It’s a load of crap and it’s been revealed to be so.

Now, I’m saying all this and I have a mortgage.  Unfortunately, much of my education came after I got into a house.  Does that make me less credible on the subject?  You can decide.  I can tell you if I knew what I knew now, I would have been renting for several years now.

Does this mean that you should only pay cash for a house?  Well, yeah, sort of.  It means you should minimize your expenses on your residence as much as possible.  If that means paying cash, then that’s what you should do.  Seems extreme, no?  Maybe it only seems extreme because we’ve been so conditioned to think mortgage debt is a way of life.

 

44 Comments »

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  • 20smoney said:

    Now we're talking different stuff. Primary residence = an expense. I do believe in the use of debt for higher rates of return (assuming a large number of factors are good) and that includes rental property.

  • Cedric said:

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  • Danielhendr said:

    So you say that if you knew now what you knew then, you would be renting. Isn't that pretty much everyone who bought a house within the last 5 years. It's like saying I wish I didn't own stocks before the recession if i knew then what I know now. And if you knew now what you knew when you bought your house you would have waited 5 years and bought now or invested in property with your down payment. If people could see the future we'd all be millionaires. I think the key to Rule number 1 on paying with cash is so you can rebound quicker when hard times come. Those with 2 mortgages on a house, credit cards, low down payments on houses we're hurt the most from the recession.

  • flbuzz said:

    Nowaday, personal loan is important for living and when people need to be home owner, they need to apply a mortgage loan.

  • JayBandit said:

    So, what exactly are you suggesting people do? Everyone should rent, and they should buy a crappy car that they can pay for in cash? What if you can't afford any car in cash right out of school? I think your suggestion is extremely severe, and I think you agree with me in practice since you didn't sell your home once you came up with this idea.

  • MacKenzy said:

    New economic era–we need to re-define "expenses". I think non-financial assets such as primary and vacation homes are also expenses. Don't borrow money for those either

  • Sterling Effort said:

    I don't enjoy the stress of home ownership or the burden of being tied down to my home but I think buying my house is one of the best financial decisions I've ever made. With interest rates (in the UK) at historic lows, money is cheap and I have a friend living with me who is basically paying my entire mortgage. If I sold this house, there is no asset class to which I could transfer my equity to enable me to afford rent free. I really think the whole buying vs renting argument needs to be taken on a case by case basis. It depends on so many factors.

  • Tommy said:

    Very well said. Thanks for the first rule of thumb.

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  • Cassie said:

    I like Rule #1 and JayBandit, I do think he's saying if a crappy car is all you can afford to pay cash for then that's what you buy. Then you save like crazy and step up in car.

  • JayBandit said:

    My point is, if you take this advice as it is given, you might have next to no realistic options out there. If you're a kid out of college, and you don't have a good family support system to lean on, you will only have the money in your own bank account (likely to be very small), and what you can start earning on a monthly basis.

    When you start out on your own, odds are you will have to take on some sort of debt, which is all I was trying to state. I'm not saying that I expect to drive a bmw and live in the hamptons.

  • JayBandit said:

    And to clarify, I'm talking about DAY 1 of your life out of school. I know in my personal experience, I obtained a job that began only 3 weeks out of college making over $50k, but I didn't see any money in my bank account until the end of the month. I had to borrow money from my folks in order to pay my initial bills and cover my immediate expenses to start off. If someone didn't have parents that could lend them some cash, then they'd have to take on debt in another form.

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    I am not in agreement with this article: The author has presented a very simplified view of finance that eschews the key underlying concept of understanding present and future cashflows. Debt is not bad; uncontrolled debt is bad. Letting someone give you 400k in today's dollars at 4% is a hell of an opportunity given the likely path of the dollar.

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