My family has a decent amount of money. That’s something that, frankly, is probably not going to be true about me–basically, I’ve chosen an academic path that won’t lead to big riches. That’s okay with me, but I do want to protect myself and provide for my future family, so I think it would be smart for me to learn some of the principles that have helped the wealthier members of my family: things like budgeting and investing and such, which I can then implement on a smaller scale with my smaller income and (hopefully!) smaller expenses. I’m hoping for some tips from the experts, particularly about debt and saving: I know that you should spend less than you earn and not go into debt, but why are some types of debt considered so much better than others (for instance, my financially comfortable cousin has a car loan and a mortgage–why wouldn’t he just pay those off?).
Wealthier Americans–like those in your family–do have access to some ways of maintaining and producing wealth that are out of reach of the rest of us. But you’re quite right to say the basic principles of saving money, building wealth, and avoiding debt are applicable to virtually all of us, and that we could all learn a thing or two from the careful savers and investors in your family.
You have the basics right: spend less than you earn, save money, and invest. Your confusion about debt is understandable, though, so let’s talk about budgeting, buying, and borrowing–and how all of these things can build wealth.
For starters, not all debt is created equal. High-interest, short-term debt like credit card debt can mount quickly, because the interest earned is added to the debt you owe and the interest compounds, meaning the next interest penalty is even higher. (This principle of compound interest is the exact same one that works for you when you invest money in stocks and bonds.)
But some debt can be perfectly health. Mortgages are a good example, and so are car loans, say the retailers at Artiolo Chrysler Dodge Ram in Enfield, Connecticut. In the case of mortgages, car loans, and other “secured loans,” there’s collateral: the lender can confiscate something if you don’t pay your debt. That may seem bad for you, but in practice it can be good: with that added security, lenders lower their interest rates, making these sorts of debts more manageable. And healthy debt like a mortgage means you’re investing in something that can grow in value, potentially outweighing the loss of interest payments.
But lower interest isn’t no interest, so wouldn’t your cousin still want to pay off his loans? Well, that all depends on what kind of interest he’s making in his investments, say investors at Zhang Financial in Battle Creek, Michigan. Perhaps he’s making more in interest in his investments than he’s losing in car payments, meaning that it makes more sense to keep more money (by not paying for the car all at once) and keeping that money invested. Further complicating this situation are various tax laws, including some tax breaks that make mortgages more appealing.