Written by Ryan Ovenden, Wealth Advisor
I have a lot of trees on my property, so naturally I decided to purchase a chainsaw.
Prior to purchasing, I was fairly cautious about using one. However, after watching several hours’ worth of training videos online (the best place to learn nowadays, right?), my fear of chainsaws rose to a much healthier level.
Why is this so?
One word: Risk.
There are literally dozens of ways you can kill or maim yourself using a chainsaw. Believe me, I witnessed plenty of demonstrations. My goal suddenly became to learn all of them so that I could steer clear of the risks and observe potential hazards while employing this dangerous tool in my backyard.
Debt is a lot like my chainsaw.
Those who treat debt cautiously and use it only when necessary tend to use debt in a progressive way. Those who don’t often get hurt by it!
When discussing personal debt, it’s important to view it as the potentially dangerous tool that it is. Debt has ruined lives and stolen freedom from countless people, and it must be managed properly to reach the pinnacle of wealth that we call true wealth.
Let’s walk through some of the most common debt-related concerns we hear and our responses to each.
1. How much debt is too much?
This question makes me think of a child interrogating their parents to see how far they can stretch their boundaries.
It’s the wrong question to ask.
The question should focus less on how far you can go in your relationship with debt and more on how little debt you can do with. Ask yourself the following questions for clarity on whether you should move forward with debt assumption:
● Why am I taking out this debt in the first place?
● Is the thing I’m purchasing a need or a want?
● Is the risk of debt called for?
● Will the long-term benefits outweigh the cost of servitude to the debt?
● Do I have a plan to pay off the debt as fast as possible?
After honestly answering each of these questions, you should find clarity on the necessity of the debt.
From the lender’s perspective, your debt-to-income (DTI) ratio is a standard for calculating how much debt you can afford. This number is calculated by dividing your gross monthly income from your monthly debt obligations.
Many lenders will place a limit around the 35% mark, meaning you should at minimum aim for debt payments under 35% of your income. This includes any mortgage payments.
However, we strongly discourage clients from this DTI mentality. Our advice is to aim for the 0% mark rather than the 35% mark — i.e., to aim for debt-free living. Doing so can be the single difference in having to live paycheck-to-paycheck and generating lasting wealth.
2. When is it okay to use debt?
By now, I think I’ve made it clear that debt can be a dangerous tool. But it is a tool nonetheless. If you are to use it, here are some practical considerations to keep in mind:
● Take only the amount of debt you need. No more.
● Never take on debt to purchase a depreciating asset. You are effectively paying more for an item that will eventually be worth less, which is far from a wealth-building formula. Examples of commonly depreciating assets include:
○ Lake toys (boats, jet skis, etc.)
○ Electronic Devices
● Have a plan to pay off all debt early, if possible, no matter the interest rate.
● When you become fully debt free, try to avoid future debt at all costs.
Debt is not a tool we encourage at Pinnacle Wealth.
There are some instances in which we absolutely discourage it, but there are also a few instances where we “okay” it. Having a purposeful discussion with one of our advisors is always a wise idea prior to taking steps toward the path of debt.
3. How does debt affect my credit score?
Credit scores are important to anyone who borrows and lends money. (Okay, Captain Obvious.)
I note this to remind you that there is no inherent value to the score. Most people become so hung up in their credit score that they lose sight of how little it actually impacts their well-being.
But if you are to borrow money, lenders want to see that you have a low risk of defaulting on the debt. The lower the risk (i.e., the higher your score), the cheaper the debt will be for you.
FICO scores are the standard credit score measurement in the United States.
FICO scores are calculated based on the following categories:
● Payment history (35%)
● Amounts owed (30%)
● Length of credit history (15%)
● New credit (10%)
● Credit mix (10%)
The primary area in which you have full, immediate control is payment history. Each time you make an on-time payment, your “trustability” factor increases with your lender.
The second biggest factor is the amount you owe. Generally speaking, the lower you owe, the better. Borrow the smallest amount you can for only the things you need and pay those debts off as soon as possible. Avoid the temptation to borrow money with the sole intention of increasing your credit score. This rarely results in the borrower’s intended purpose and only leads to additional stress.
Wealth is generated by focusing on asset growth and liability reduction — not raising your credit score.
Debt acts as a weight on your shoulders: It applies more pressure on you to produce income in order to pay the debt.
At Pinnacle Wealth, we strive to guide our clients toward peace and fulfillment — financially, physically, and spiritually. With debt discussions, it’s important to remember that the sum of your accounts is not the sole measure of your success and happiness.
I personally know many wealthy people (financially speaking) who struggle to sleep at night due significantly to their debt loads and financial predicaments. At the same time, I know many people with fewer assets and much fewer liabilities who appear vastly more content.
1 Timothy 6:6-8 says, “Godliness with contentment is great gain.”
Don’t allow debt to lead you toward the wide path of greed and discontentment. Be content with what you have been blessed with while striving to grow your definition of true wealth.
Ryan is not registered with Cetera Advisor Networks LLC.