By FPA member Nathan Gehring, CFP®
Last Updated: July 5, 2011
Google "debt" and you'll find a variety of results. Wikipedia returns a very rigid literal definition of debt. A page on Dave Ramsey's website, titled The Truth About Debt, sits high in the results and is a worthwhile read. None of the pages, however, really help you understand what debt is. They don't explain what debt is in your life and what debt means to your financial well-being.
Debt = Relinquished Control
There are many pieces of our financial lives we have control over; how we save and spend our money, what risks we choose to accept or insure, what desires we pursue today and which we defer for the future. Maintaining control of these factors provides us with one of the best paths to keeping and improving our financial well-being.
Taking on debt means relinquishing some of that control. Taking on debt creates a non-negotiable payment that must be accounted for in your budget. It is not a variable expense that you can adjust as necessary. It is not an expense you get to decide to skip for a month if you desire. Taking on debt represents abdicating a piece of your financial control to the party offering you the credit.
Conversely, paying off debt equals gaining financial control. You gain a stronger and stronger grasp of your financial well-being with each portion of debt eliminated. When a debt is eliminated, you have removed that non-negotiable monetary outflow from your life. You have taken back control of that money.
Debt = Evil?
But debt is not evil. Debt is not intrinsically a negative force on your financial well-being. Debt is neither good nor bad. Debt is a financial tool that can be used wisely or poorly. When used wisely, it can benefit your financial well-being and benefit your overall well-being. When used poorly, debt can have a profound and negative impact on your life. But it is not debt that causes either outcome. That is entirely up to the operator (you) of that debt.
You should understand the terms of any debt you incur. How must it be repaid? What is the interest rate and how could the rate change in the future? What potential penalties exist? Whom do you negotiate with if you have difficulties in the future? These and many other questions should be asked and answers understood.
Is Debt for You?
That really depends on how you will be as an operator of that debt and where you are trying to go. As you consider debt, answer the following questions to help determine if you can afford to give up some of your financial control:
- Have you established an emergency fund?
- Are you well-disciplined with your spending and budget?
- Have you done well using debt in the past?
- How much debt do you currently carry?
Ultimately, you should determine if you have the capacity to give up a piece of your financial control. Then, decide if you actually have a desire to give up that financial control in return for whatever you hope to purchase with the credit.
It is important to recognize that if you choose to take on debt, you are giving up some control of your financial life. When you accept debt and give up financial control today, your ability to give up control in the future is reduced.
Debt is...a decision to give up some financial control.
FPA member Nathan Gehring, CFP®, provides financial planning services to young individuals and couples at My First Financial Planner, a service of Conceptual Investment Advisors, Inc.