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Good Debt, Bad Debt: Knowing the Difference Can Save Your Financial Life

Good Debt, Bad Debt: Knowing the Difference Can Save Your Financial Life

by Jon Hanson

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Debt is just like cholesterol. Too much of the wrong kind can kill you. But too little of the right kind can be a problem too.

Just as not all kinds of fat are equally bad for your health, not all kinds of debt are equally bad for your wealth.

Jon Hanson learned about debt the hard way, barely surviving his own “near-debt experience.” Now


Debt is just like cholesterol. Too much of the wrong kind can kill you. But too little of the right kind can be a problem too.

Just as not all kinds of fat are equally bad for your health, not all kinds of debt are equally bad for your wealth.

Jon Hanson learned about debt the hard way, barely surviving his own “near-debt experience.” Now he can help you avoid the same fate. Good Debt, Bad Debt doesn't offer quick-fix solutions. This isn't optimistic taffy to soothe your ego. It's about embracing the reality of where you are financially and working to improve your position. Hanson explains that “debt takes more than your money. It takes your freedom, time, peace of mind, and opportunities. Debt makes cowards of us all.”

Good Debt, Bad Debt concentrates on what you can do using your present income. It blends personal stories, research, history, and humor to build the argument for living life with a plan, instead of allowing yourself to be controlled by your emotions and impulse spending. With a new chapter on debt warfare, Jon Hanson will bring you out of the financial trenches and show you how to wage war against the most difficult personal economic pitfalls.

Editorial Reviews

Library Journal
Hanson spent years in the real estate business and is currently a self-styled financial sanity planner. He has taken his own experience of being in debt and attempts to write words of wisdom based on these experiences. Unfortunately, there is nothing new here. The author makes mention of his past debt problems but never explains how he got into debt (e.g., how did he come to owe the IRS over $78,000?). Each chapter starts out with quotes (most by the author himself) and ends with "Points To Ponder." Good debt (debt that increases your net worth or cash flow) is differentiated from bad debt (debt that decreases your net worth), and typical advice on how to avoid debt (e.g. delay gratification) is given. There are some suggestions on how to increase your good debt, such as investing in real estate (how relevant is this to most people?), and how to evaluate your partner for financial stability. An optional purchase for public libraries.-Stacey Marien, American Univ., Washington, DC Copyright 2004 Reed Business Information.

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A Matter of Life and Debt

Never itch for anything you aren't ready to scratch for. —Ivern Ball

It is hard to fit yourself for joy while spending money on temporary happiness.—Jon Hanson

How are you doing?
How are you really doing?
Are you financially fit or financially spent?
Are you scratching it up or stacking it up?
Are you living the life you imagined—or an unimaginable life?

In America we have both enjoyed and abused the privileges of our society. Yet many are experiencing an implosion of insecurity and vagueness of purpose that leaves them vulnerable to clever merchants seeking to plunder their infant wealth.

Just what are you working for? A quick test: Take your net worth and divide it by the number of years you have worked. What's your result? Seem lower than you thought? This number is how much you are working for per year. The rest is gone, burned up, consumed. It has gone to burn rate, which is described later in this introduction and in Chapter 3. There are other important measures of wealth, such as income, but you'll soon find that income and net worth like to hang out together. If your net worth is $100,000 and you have worked for ten years, you are effectively working for $10,000 a year, even if your actual income is $75,000 a year or more. Don't feel bad. With bad debt, some are working for room and board only; others have a negative net worth.

Certainly life is more than getting and spending money, but because money does necessarily and inescapably affect so many areas of life, it is the main focus of our attention in this book. Good Debt, Bad Debt is not about living a starved orpinched existence. It is about gaining perspective and right-sizing spending and saving while keeping retirement aspirations in line. It is about developing a philosophy of debt—or, for many people, a philosophy of no debt. Good Debt, Bad Debt encourages us to avoid the consumer entitlement mentality that can only lead to debt, regret, and broken dreams—not to mention a garage and basement full of junk.

What Good Debt Is

Good debt increases your net worth. Good debt helps you make money; the use of good debt adds to current earnings, net worth, or foreseeable earning ability. On the other hand, bad debt decreases your net worth. Bad debt takes your money. Payments on bad debt reduce cash flow. Compare:

good debt
. Earns its keep
. Increases your net worth or cash flow
. Secures a discount that can be converted to cash or net worth
. Creates a leveraged position with a strong margin of safety
. Examples: debt for real estate at a safely leveraged level, debt for education that can be applied for a return of capital, debt for a business you are competent to operate

bad debt
. Is typically for consumption
. Decreases your net worth or cash flow
. Absorbs future earnings
. Examples: car loans that rob your retirement fund;
continuous credit card debt

What Good Debt Isn't

It's easy to rationalize anything we want to do with our money. Advertisers even train us to overcome our own objections! We have all done this; I have done it many times in my life. Whether your excuse is to feel better about yourself or the catch-all “I deserve it,” the fact is that rationalizing debt and callin reality of your financial position. Stacking bad debt on a good asset does not make it a good debt.

Stacking bad debt on a good asset does not make it a good debt.

Refinancing of personal residences has become a popular sport in America. It can be good, if done for the right reasons. The problem is that many people refinance to pull out cash or lower their payments, only to increase their debt with their newfound cash flow. For many, it only means freeing up their credit cards to be maxed out once again. Then they have all of their old credit card debt on their home and a new stack of debt beside it to contend with. Some believe that all debt on real estate is good debt. That is insane. Some lenders are willing to go 110 percent of value on real estate, so without discipline, disaster lies ahead (for both the lender and the borrower). Unless you have a real change of heart and discipline, do not stack credit card and consumer debt on your home equity. If you are considering consolidation of bad debt that will encumber home equity, please read the white paper Debt Warfare first. Get it free at www.gooddebt.com.

Monkey See, Monkey Do?

Some Americans are beginning to question the popular notion (fomented by advertisers and popular culture) that everyone must pursue his or her own inclinations, regardless of the damage to self or society. We are seeing the result of promiscuous spending, easy credit, and, in the end, skinny or nonexistent retirement plans. Too often, debt becomes a weapon that we unwittingly turn against ourselves.

We are seeing the result of promiscuous spending.... Too often, debt becomes a weapon that we unwittingly turn against ourselves.

In The Millionaire Next Door, Thomas Stanley and William Danko discovered that average self- made millionaires save or invest 15 to 20 percent of their disposable income. In The Overspent American, Juliet Schor found that average Americans spend 18 percent of their disposable income on consumer debt payments while saving little or nothing. In this sad juxtaposition lies a key premise of Good Debt, Bad Debt: “The past is the past—unless of course you still owe for it.” Many can't start up the hill of financial freedom because they are carrying a backpack full of debt.

This would be obvious if only we could step back for a moment and look at how we allocate our income. Madison Avenue and the merchants of debt heap the polite fiction “you can have it all” and “you deserve it” upon the average consumer thousands of times each day. The goal of Madison Avenue is to distract you while the merchants of debt pick your pockets.

In a recent radio broadcast Alistair Begg said, “Our society thrives on materialism, cashing in on the sin of covetousness. Its modus operandi is to create within our hearts a longing for the things we do not have. Not only a longing, but also an attitude of need and entitlement. We need it. We deserve it. Especially if someone else has it.” Of course, we have free will (to a certain extent). It is up to us how we respond to messages from Madison Avenue.

Fat, Old, and Broke

Isn't it amazing, at least for a time, how resilient our bodies and our finances are? Eventually, though, poor eating and poor financial habits begin to take their toll. In the book Good Fat, Bad Fat, Drs. William Castelli and Glen Griffin counseled readers to distinguish between types of fat that clog the arteries and those that are not harmful. In Good Debt, Bad Debt, I counsel readers to engage in similar discernment as to consumer debt. The statistics on obesity are eerily similar to the statistics on debt problems. The Employee Benefit Research Institute and the American Savings Education Council report that 66 percent of Americans are unable to save enough for retirement because of current financial responsibilities (debt). Peter Jennings, in a special report on ABC News, said that 66 percent of us are overweight. Let's hope the two groups aren't the same people. Being fat is bad enough. Being fat, old, and broke is even worse.

The buildup of cholesterol in our veins is barely noticeable until the restricted blood flow begins to cause problems. Many people go for years with cholesterol-clogged veins, never realizing the problem until it is too late. For some, a stroke or heart attack may be the first warning. For others, death is the first warning.

A similar process operates in our finances. So long as we have enough blood flow, er, cash flow to pay the bills, we don't see a problem. But in the background, too much debt, like too much cholesterol, looms as the number one killer of wealth and possibility. Once we begin to clog our financial arteries with bad debt, we may experience shortness of opportunities and high debt pressure. Unchecked, this may lead to financial death or at the least a financial infarction.


In The South Beach Diet, Dr. Arthur Agatston writes of becoming healthy and fit through eating the right foods and balancing good carbs and bad carbs together with good fats and bad fats. In Good Debt, Bad Debt, I am advocating financial health and fitness through balance of good debt and bad debt. Agatston speaks of “a silent, so-called metabolic syndrome (prediabetes) found in close to half of all Americans who suffer heart attacks.” I sense a similar development in many Americans' finances, perhaps a financial prediabetes syndrome. Let's call it pre-Debtabetes. Debtabetes is the inability of the body to break down and eliminate debt because of insufficient cash flow. Debtabetes is most common in the debt-obese and is closely linked to financial strokes—either fatal or temporarily debilitating. To carry the analogy a little further, we could consider spending as your glycemic (blood sugar) index and cash flow as your financial insulin. To be physically fit and financially fit requires awareness and implementation of many similar skills.

Debt Philosophy

Mr. Jim Rohn asks a great question of his audiences: “If we took your philosophy of life, and got it all down on paper, would you be excited about traveling all over the world giving talks on it?” If not, he suggests, you start there—reworking your philosophy. I labored over Mr. Rohn's challenge for months. In fact, it was the driving force behind completing this book. I ultimately wanted a book I could hand to my children and say, “Here are my core financial beliefs—they are as fundamental and as sure as gravity.”

Many financial books present supplemental, not fundamental, principles. Financial failure begins in the thinking process before the actual spending. George Orwell said, “People can't write clearly because they can't think clearly.” I try to avoid tortured logic and incomprehensible phrases that are the result of a confused mind. I'd expand this to finances too. Confused thinking causes confused spending.

After my IRS debacle, as discussed in the Preface, I realized that my primary downfall in the area of finances had been lack of discipline. While I had done pretty well overall, I felt I could have done much better. Here are three traits of my philosophy that apply to finances. To the right of them, you see the parallel yet antithetical traits advertisers and the merchants of debt want you to embrace:

econowise traits:
1. Discipline
2. Deferral
3. Discernment Result: Lasting joy

consumerati traits:
1. Indifference
2. Immediacy
3. Ignorance Result: Temporary happiness

Most men and women do not make their daily decisions based on a calm weighing of risks and benefits.

Consumerati versus Econowise

The Consumerati are what I call those who are spendthrifts, living hand to mouth and in general never thinking of tomorrow. Consumerati are proficient at consuming at any cost. For the most part, they are well-meaning people whose ambitions far exceed their obedience to the fundamentals of money. They respond to emotional marketing appeals and, once they run out of cash, it seems only natural to use bad debt or consumer debt to pay for their wants. We all have a little Consumerati in us. According to Cardweb.com, 50 percent of Americans pay the minimum or far less than the balance due on their credit card bill. Twenty-nine percent pay off their cards monthly. Twenty-one percent of all households in America do not have credit cards. The Consumerati are likely to confuse income with wealth. They don't understand an age-old fact that spending, and not income, determines wealth. Income is like a moving river—wealth is like a lake or reservoir. See the beginning of Chapter 3 for more on this.

The Econowise, on the other hand, think about how today's actions will affect their future. If we merge economy and wisdom together, we come up with the Econowise—people seeking both economy and wisdom. The Econowise plan on paper and understand how burn rate, delayed gratification (Chapter 4), and avoiding the debt effects (Chapter 1) all can work together to create a prudent lifestyle. The sooner you eliminate the waste, lower your burn rate, and begin an Econowise program, the better.

The definition of burn rate is all the money spent that does not increase your wealth. Burn rate is what is consumed and gone forever. Taxes are a major part of your burn rate, together with food, shelter, and transportation.

Give Me the Best

The last five chapters of this book are more about doing than just philosophy building. Money Magazine writes that recent studies by economists from New York University have found that a willingness to plan is closely linked to wealth accumulation. Before you dismiss this statement as self-evident pabulum, ask a few acquaintances how to become wealthy. Many will answer, “a large income and an inheritance.” A large income is not necessarily a guarantee of wealth. Nor is an inheritance a guarantee of wealth. It can soon be frittered away. On the other hand, income of almost any size when strained through well-trained habits can create wealth.

Both Plans Are Scalable

The planning and saving habits of the Econowise scale to make them wealthy as their income increases over the years. The nonplanning and debt abuse habits of the Consumerati likewise scale to make them poorer and deeper in debt as their income increases. In other words, with a Consumerati lifestyle, if you are unhappy with your life while earning $40,000 a year, you will despise it at $110,000 a year.

Life is truly asynchronous. What you do today may not have an immediate effect but may have a very large effect later in life. The whole personal finance field is pretty simple, a near mathematical certainty—until you add in one thing: human emotion. Most men and women do not make their daily decisions based on a calm weighing of risks and benefits. Most are emotional beings who respond to vague if not nonsensical messages such as “You deserve the best.” Hold on! Isn't “the best” a plan that will provide you and your family with a lifestyle you've not only dreamed about, but planned for and earned? Don't seek someone else's best—seek a plan you have designed for your life, a plan that is best for you.

It's One Thing to Admit Your Stupidity—
It's Another to Escape the Consequences

This is not an offering from the Self-Esteem Is Free Institute. Good Debt, Bad Debt is aimed at two distinct groups: those who realize that they are groping in the dark, financially speaking, and those who are doing OK but think they could do a little better. I call the blind gropers the Consumerati. They enable Madison Avenue and the merchants of debt to enjoy record earnings year after year in post-responsibility America.

To Consumerati, delayed gratification is an alien concept. Despite being part of the richest and most educated group in American history, Consumerati suffer deeply from the seeming inability to get a grip on the financial rudder. The Consumerati are, for the most part, slaves to their emotions. They are sure that they must follow their feelings to get what they deserve. The world around them seems to confirm this—they deserve the best, don't they? Consumerati men and women strive to maintain or create an image that is neither healthy nor fiscally responsible. Relax. Good Debt, Bad Debt will concentrate on what you can do using your present income.

Personal finance is simple, requiring little more than basic math and sincere forethought. We only need add human nature to finance to make it both funny and tragic.

My Objectives for Good Debt, Bad Debt

Here are my goals for Good Debt, Bad Debt as set out in my journal:

1. Brevity—To make literary bouillon cubes with a financial flavor.
2. Wit—Humor with its thinking cap on. Laugh or smile while learning.
3. Visual humor—Cartoons with a lesson of financial frugality.
4. Incontrovertible arguments—Arguments with results that are verifiable (knowable) in advance.
5. Fun—A book that's fun to write, read, and share; one that creates useful new words and terms.

Brevity. Would you buy a 763-page book called How to Be Brief? Mark Victor Hansen of Chicken Soup for the Soul fame says that most people have about two hours to spend with a book, perhaps on a short flight from Boston to Atlanta, in the evening at home, or over a couple of lunch breaks. The thinking in the book is no more important than the think- ing caused by the book. See www.gooddebt.com for discussion guides.

Wit. My catchphrase “The past is the past unless, of course, you still owe for it.” It seems that many people can't go where they want to go because of where they have been. Truly, what constantly pulls your past into today? Debt. If I tell a church audience, “It's hard to give your heart to Jesus when your butt belongs to MasterCard,” they understand the message. Not only is it scriptural, it is common sense. When I refer to spendthrifts and those striving to keep up with their imagined reference group as the Consumerati, and people who follow a plan and seek wisdom as the Econowise, it's easy to follow. It makes sense.

Visual Humor. Throughout Good Debt, Bad Debt you will see original cartoons by Patty Kadel. When I developed an idea for a cartoon, I would put it in writing via e-mail or letter to Patty, who would turn my concept into a drawing. You will probably have your favorite. Here's mine—a guy dripping with talent who suffers from the inability to gain financial traction because he lacks discipline. Talent is only one part of success. If you flip to Chapter 10 (“You Married Who?”), you will see a cartoon on “relationship baggage” that generates a great deal of comment. We have all seen this type of relationship. It's a simple concept, but many overlook it or seemed surprised when the “unpacking” starts. I had a great deal of fun doing the chapter on marriage, an area in which I've done well. My wife, Nita; my son, A. C.; and my daughter, Paige, are a perpetual blessing.

Incontrovertible Arguments. Our arguments must have both texture and depth, or our success will be short lived. After the smile wears off the words, does a residue of wisdom remain? Few will argue with the saying “You must spend less than you make. You must have capital to capitalize.” The first five chapters are about developing a philosophy of debt or avoidance of most debt. Except for business or investment debt (at safe loan-to-value ratios), the goal, in time, is to have everything in your personal life debt free.

“It's hard to give your heart to Jesus when your butt belongs to MasterCard.”

Fun. Personal finance is simple, requiring little more than basic math and sincere forethought. We only need add human nature to finance to make it both funny and tragic. While fun is not an absolute prerequisite for success, it does make the more mundane but necessary parts of life easier to accept. If you can laugh at others' inability to embrace discipline, delayed gratification, and discernment, then perhaps you can learn these lessons without the unpleasant aspect of firsthand experience.

What's NOT in Good Debt, Bad Debt

No quick-fix temporary solutions. No optimistic taffy to soothe your ego. Good Debt, Bad Debt is about embracing the reality of where you are at and working to improve your position. You won't find specific to-do lists and forms to fill out. No slavish devotion to budgeting. When your reasons are right and you can foresee the promise of a prudent financial philosophy, you won't need someone to micromanage your life. All things will work together for good for those who embrace sound financial fundamentals. Good Debt, Bad Debt will concentrate on what you can do using your present income.

What's IN Good Debt, Bad Debt

How should you think about debt? Is debt good or bad? Can debt be an effective tool? This is a book to help you develop a philosophy of debt, spending, and saving. Good Debt, Bad Debt is about fundamentals—time-tested and, sadly, debtor-proven ones. It's about building a foundation for your future.

Some of it is tongue-in-cheek, but not so outlandish that people can't relate to it. For example, in Chapter 1 (“The Debt Effects”), I say, “Credit cards are the crack cocaine of the credit industry.” I am not actually accusing the industry of drug pushing, just something close.

Throughout I encourage a healthy skepticism which will allow you to deconstruct advertising and media messages. Think of it this way: you edit what comes into your mind, or else the media and advertisers will. In Good Debt, Bad Debt I teach you to question the media and merchant messages you receive hundreds, even thousands, of times a day. When you hear the message “Don't put all of your eggs in one basket,” you will wonder if the message was sponsored by the National Basket Makers Association.

Think of it this way: you edit what comes into your mind, or else the media and advertisers will.

Understand the debt effects, manage emotions, deflect media influence, work from a plan, monitor burn rate, delay gratification, track and tabulate expenses, and invest for your future. That's simple enough, right? Grasp the first four chapters and you will have a better understanding of debt and money than 90 percent of Americans. Actually put these fundamentals to work in your life as a financial liturgy, and you will finish financially ahead of 97 percent of Americans. How are you doing? How are you really doing?

Chapter One
The Debt Effects:
The Invisible Hand of Debt

The ten-second lesson: “The past is the past—unless, of course, you still owe for it.”—Jon Hanson

Consumer debt since 1999 has grown an average of 14.6 percent per year.—ABC News

Liberty or Debt?

“Give me liberty or give me death!” cried Patrick Henry, admonishing his fellow legislators to take up arms against the British for American sovereignty. That was in 1775. In today's culture of excessive spending, perhaps Henry's cry would be “Give me liberty or give me debt!” The British have retreated, but millions of Americans, by their own choice, allow credit card companies, mortgage lenders, and every known form of debt or monthly obligation to carry on the work of enslavement. Patrick Henry's famous speech could apply as easily to debt as to death. It is natural to indulge in illusions of hope—to think that our path is unique, that it cannot lead us to the same end as it has led others. We hear the siren song of popular culture and we are seduced by it, transforming into the typical consumer. Avoiding responsibility, we are given over to our emotions until finally we collapse under the weight of our own desires.

In America you will not be singled out or made fun of for wasting your resources. In fact, you will have many cheerleaders, although most of the cheerleaders will be people who profit by selling you trinkets and assorted junk. Just because millions of others share this same practice of spending everything they earn does not make it a right or proper path to follow.

The culture of spend, spend, SP: is necessarily created by merchants to keep their coffers overflowing. It has been said that more than 60 percent of the economy is based on consumer spending, in part financed by consumer credit. For those who collect the money, this spending culture is rewarding. For those doing the spending, it is enslaving.

Many speak the language of free men and women, yet daily proceed in the opposite direction.

So What?

The stigma of debt seems nonexistent today. Not so long ago, many Americans regarded debt as a sign that something was morally wrong. Perhaps the availability of credit cards and revolving debt has made us more adventurous and greedy. Also, credit has become abstract and anonymous. Instead of owing the corner grocer and feeling a moral obligation to him, you pay (or don't pay) your credit card bill to a faraway faceless company. The grocer and dry cleaner will still smile and wave hello.

But the “debt effects” linger. Look around—you needn't look far to find someone suffering from the effects of debt. Those not yet suffering may very well be on the road to perdition without even knowing it. Many speak the language of free men and women, yet daily proceed in the opposite direction. Henry Taylor, in Notes from Life (1847), wrote, “A right measure and manner in getting, saving, spending, giving, taking, lending, borrowing, and bequeathing would almost argue a perfect man.” Today Taylor would change nothing in this sentence other than ending it with “a perfect man or woman.”

Not everyone has the moral or intellectual stamina to set into action a purposeful plan for the future. Yet only those who develop a plan and follow it will succeed.

Those who live in a constant state of “want” become slaves to their own passions. Many go further—voluntarily putting on the shackles of debt—not only spending all they earn but also borrowing into their future for today's excesses. When we use debt to acquire products or services, it is not really a payment for the product or service, but a claim on future earnings.

In its early stages, debt causes no pain. On the contrary, the insidiousness of debt lies in the very fact that the use of debt gives its victims temporary pleasure. A large majority of Americans will risk financial leprosy to have the temporary pleasure afforded by spending in advance of earning.

Debt—the Equal Opportunity Enabler

Credit to the untrained appetite distorts reality. It provides the emotions with vast avenues to explore. Credit allows emotions to trump math—stretching our purchases far into the future and reducing the “right-now cost” to a few dollars a month. Soon the emotion subsides and you are left with the reality of the math. For some people it's like the directions on a shampoo bottle: apply, lather, rinse, and repeat. Apply credit, lather up your emotions, and rinse away your monthly cash flow. Repeat.

Most consumer credit advertising uses the “bump and pick” method I discuss in Chapter 2 (“Emotional Hostage”). If you have been part of the buy-now/think-later crowd, take a deep breath and think, Now is the time to begin serious change.

Debt Takes More Than Just Your Money

Adam Smith is famous for his theory of the invisible hand of capitalism. He said that laissez-faire (left-alone) markets naturally adjust because of the self-interest of consumers and the owners of capital. I don't dispute the Scotsman's theory. The sentence above is less than a thumbnail sketch of the whole. I bring it up to propose an antithetical theory: the invisible hand of debt. Many of us look fine and probably are as long as we can make the payments for our excesses. But are we really making any financial progress?

Credit to the untrained appetite distorts reality.

What holds us back from financial success? The most evident of my four debt effects, loss of cash flow, is easy to see; the others may operate invisibly. In Smith's invisible hand theory, capital seeks opportunity to expand and grow, as it is good for the individual owner of the capital and the consumer. In my invisible hand of debt theory, Consumerati individuals suffer from the invisible or nearly imperceptible loss of both time and opportunity. On one hand, consumer debt (bad debt) fuels capitalist ventures because it creates sales and moves the economy. On the other hand, if too much consumer debt is used, the invisible hand of capitalism metaphorically reaches out to slap the consumer as it morphs into the invisible hand of debt. Once we reach the tipping point with consumer debt (100 percent burn rate), we lose the opportunity to participate in a capitalist society. We are on the road to serfdom.

The Four Debt Effects: The Four Thieves, or How the Invisible Hand Operates

Always remember that debt takes more from you than just money. It is easy to think of debt simply in terms of bills to be paid, but it is so much more. There are four major debt effects:
Loss of freedom Loss of cash flow Loss of time Loss of opportunities

Certainly debt may cause problems beyond these four, but most difficulties come in some form of them.

Loss of Freedom. Debt will eventually keep you from doing what you want to do. When you are loaded with debt, your options narrow considerably. I have often said, “Working while carrying a load of debt is like a prison work-release program. You are released each day to work, but the balance of your time is spent in a mental prison.”

Do you work for joy or to avoid the pain of losing your possessions? With a high enough debt-to- income ratio, you may cross a threshold or amount of debt that simply renders earning money a way of avoiding pain. Real progress or joy seems a distant memory.

In ancient Babylon, a slave was able to earn a few extra shekels on his own time, after completing his master's work, to save toward buying his way out of slavery. He could actually redeem (repurchase) himself. We, too, may redeem ourselves from the bondage of bad debt. Perhaps you do not feel like you are in bondage, but if you stop paying your bills, what happens? You find out who your master is. The more bad debt you have stacked up, the more severe your master will be in collecting her due.

Think. When you live and work from week to week, just scratching out a living, are you really any more than an indentured servant? Perhaps you feel like a prisoner who gets weekends off for good behavior. I spent seven years feeling like part of a prison work-release program while I owed a large sum to the IRS. With a high burn rate, are we really any more than a pipeline delivering the fruits of our effort to our creditors?

Is your routine to get up, go to work, come home, eat, sleep, get up, go to work, come home, and eat, only to do it all again the next day? Many people never realize the drudgery of their lives! If we can agree that entry into this cycle is voluntary, then it would follow that leading this lifestyle is also voluntary.

Did you say you are free? Where do you have to be tomorrow? Can you relocate your residence to wherever you want—right now? Or do debts and obligations have a large say in what you do? In Chapter 6 (“What If You Live?”), I discuss wealth metrics; there you find Dr. Buckminster Fuller's simple formula to calculate “useful wealth.”

One wit said, “Having a job is like taking a mortgage out on your life.” Unless you are born wealthy, you must arrange your escape from drudgery at an early age. Born without wealth, you are at least a part-time servant and are unable to do whatever you want. It is up to you whether you remain in this voluntary servitude or arrange your affairs to carry yourself to financial freedom.

From Success to Significance

Suppose you wish to change careers? If you have a high debt-to-income ratio, debt will certainly be a deciding factor. Following your passion and moving from success to significance careerwise may depend on whether you can downshift from corporate executive at $120,000 a year to teaching children to read at $0 to $30,000 a year. Or perhaps you simply want to take a few years off and write a book. That's what I did, though I had a lot going my way—while my income dropped by over 80 percent, my wife's income increased by over 25 percent. The math does not sound favorable, but our expenses are so low that we have been fine. The interesting thing is that if I had consumer debt, car payments, and high housing expenses, you would never be reading this book. I simply would not have been able to quit my real estate business and take two years to write this book if my expenses or burn rate was large.

Most of us unknowingly choose servitude when we buy into the popular culture of “you can have it all.” You can—when you have earned it. Spend the first ten to twenty years of your working career saving and investing 15 to 20 percent of your income rather than choosing to spend 15 to 20 percent of your income to service bad (consumer) debt. If you begin now, you will earn and deserve your freedom.

Freedom, as a concept, is like a hill: often it looks better at a distance. Close up, you begin to see that it can be a lot of work to climb to the top. Freedom means something different to almost everyone. Someone might think that freedom is just having the bills paid. Another person might think that freedom is all the bills paid and $3,000 a month retirement income. And yet another person might think that he or she needs $10,000 a month or more in order to retire. For our purposes, let's just say that financial freedom is a lack of necessary worry or concern about money.

Many people have created fortunes from far less income than you are currently earning, even when adjusted for inflation. When financial difficulties begin, many people believe that they are worse off than anyone who went before them. When you are debt-free, the real freedom is not just what you can do, but what you don't have to do. You are free from the invisible hand of debt.

Loss of Cash Flow. Surely this is the most obvious debt effect. This effect is first noticed when you begin to run out of “walking-around money,” a few dollars for incidentals. While most of your disposable income covers the basic necessities, a portion that could be used to eventually replace your job is busy repaying bad debt. While you may not be able to eliminate every bit of consumer debt, it's a pretty safe bet that you can pare it down and begin to invest for your future. If you are spending 15 percent of income on bad debt, the first goal is to get that down to 10 percent, then 5 percent, and eventually nearly zero. Do this while redirecting the cash flow to savings and investments, and eventually this fund alone can replace your job. This won't happen in a short time, but with diligence over ten to twenty years, the results can be amazing. How different would your life be if all the money you spend on consumer debt payments went into savings or an investment? Now consider what that would have meant over the past twenty years or what it will mean over the next twenty years. If you are age forty-something, you may project both ways: to the past and the future.

While you may lament how low the return on savings rates are now (there are other things to invest in), over the years you will realize that returns are not fixed. In 1981 some savings banks were paying 15 percent per annum. The return is not the lesson here, though—the savings habit is the lesson. In the beginning, don't worry about return. Just make sure that you are stacking up the capital. You must have capital to capitalize!

Many sacrifice their true passions to debt. Soon most of their money is allocated to “reparations” or repaying for past spending. Their passions dull into complacency and are soon forgotten. They lose simply by giving debt too large of a vote in their future. Remember, the past is the past, unless of course you still owe for it. It is hard to move forward while paying backward.

They lose simply by giving debt too large of a vote in their future.

Loss of Time. If you're in debt, you must be somewhere other than where you'd like to be. Arnold Bennett, in his 1910 book How to Live on Twenty-four Hours a Day, wrote, “The beauty of time is that everyone has the same amount and you cannot spend it in advance.” Largely, Mr. Bennett is correct. But consider people who are deeply in debt—bad debt. They essentially have spent their time in advance, for they are obligated to be at their jobs to repay their debts. They have spent their time in advance of it arriving. This is what I mean by the term mortgaging your life. Certainly we sell our skills or brawn in the marketplace, but more than that we must realize that what we sell is part of our remaining time. As you grow in wealth and influence, you will value time more than you do today.

The amount of mental energy expended concerning (worrying) ourselves with bad debt vitiates time we could otherwise spend on positive pursuits. Freedom from debt and time with family and friends have begun to edge out weight loss as the number one New Year's resolution in the past few years. Many people desire free time more than additional money. The wise among us deeply value time for family and friends as well as time to write or perchance to think.

Funds already spoken for must remain silent when opportunity knocks.

Loss of Opportunities. When you see a great opportunity for financial gain, it is unlikely that you will be able to take advantage of it, because you will be financially unable to do so. The first rule of all enterprise is to know a solid value when you see it. The second rule is to be able to act on an opportunity when it arises. If your neighbor suddenly decides to sell his extra building lot for 50 percent of its true value but only if he can have cash in twenty-four hours, can you respond? This actually happened to me about a year ago (yes, I bought it). The moral of the story is this: funds already spoken for must remain silent when opportunity knocks. We lose if we have not developed the habit of preparing for opportunity. It is debilitating to sit and recount lost opportunities, but at the same time they should be lessons that we need not miss the next time. We must embrace the lesson, not the loss; embrace the light, not the dark. Truly this debt effect reaches the heart of all the debt effects. It is the silent killer of possibility and promise. I like to refer to lost opportunities as the ultimate invisible depreciation. It's easy to see the effect of depreciation on a new car, an average of $250 or more a month. It's harder to calculate the benefit of having that $250 a month accruing in a liquid investment so you'll be ready to seize a tremendous opportunity.

For Whom Am I Working?

Many people work hard to have luxuries—only to become slaves to those luxuries. In The Art of Money Getting, P. T. Barnum wrote, “Debt robs a man of his self-respect and makes him almost despise himself.” You may well ask, Do I have my possessions—or do they have me? After a few years of “prosperity,” this is the question I asked myself.

No matter how low a wage you are earning, success is within your reach. Many people refuse to believe this, since they are already living at the financial edge. You probably have everything you need; you may just be using your resources ineffectively.

Some people think that success will start only when they begin to earn a certain dollar amount or when some future event “saves” them. The problem with such thinking is, if you wait to start you may carry forward such poor financial habits that even when—or, more to the point, if—this dollar amount or event happens, it will not be enough to overcome the poor habits you acquired while waiting. The notion “I don't make enough” is more popular than the supremely accurate notion “I have poor spending habits.”

For most families or individuals, massive changes aren't needed. Usually just a reallocation of your present income can start you on the path to independence. It is usually your way of thinking and of handling the war of thoughts and desires within you that needs rehabilitation.

A few years ago I wrote in my journal, “Many have a form of wealth but deny its power through lack of discipline and unbridled desire.” Your form of wealth is the income you likely have if you are reading this book. Many people never give thought to the right ordering of finances and setting aside a proper portion of their income to offset their advancing age. Your present income can make you wealthy if you are willing to live at 85 to 90 percent of that income during the estate-building years. It is uncomfortable to consider that wealth could have already been acquired from what has long since passed through our hands.

“Many have a form of wealth but deny its power through lack of discipline and unbridled desire.”


Those choosing to live hand-to-mouth will always be a financially inferior class compared with those who take the time to plan, save, organize, and invest. Some of us compound the problem by choosing to live not only financially hand-to-mouth but also intellectually and spiritually hand-to- mouth, never building a reserve of knowledge and faith for use beyond the immediate moment. To be sure, your intellectual and spiritual development may be nurtured independently of your finances, but the most successful people build all three simultaneously. As an analogy, think of how a cable or rope is made, with three strands of the cable representing your financial, intellectual, and spiritual sides. When all three of these are woven together, they produce a cord that is not easily broken.

In Thrift, Samuel Smiles wrote, “Economy is not a natural instinct, but the growth of experience, example, and forethought. It is also the result of education and intelligence. It is only when men become wise and thoughtful that they become frugal. Hence the best way of making men and women provident is to make them wise.” If I connect Smiles's recommendation of economy and wisdom together, I come up with what I call the Econowise—people seeking both economy and wisdom.

The two main spending styles are Consumerati and Econowise. Consumerati spend all the money they have; they are the overspenders. Many Consumerati adopt a consumer entitlement mentality, eventually believing they not only need but also deserve everything they want. The Consumerati avoid the three Ds of discipline, deferral, and discernment while embracing the three Is: indifference, immediacy, and ignorance. I do not mean by ignorance that the Consumerati are literally ignorant. I mean that by design they choose to be ignorant in the area of personal finance. Just by being unaware, you are ignorant. It is an ignorance of information, not a lack of intelligence. I am urging you to avoid willful ignorance.

The Econowise on the other hand plan for life's demands; they seek economy and wisdom. The question the Econowise ask at the beginning of every spending situation is “Does this take me nearer to or farther from my goals?” A constant training in the Econowise habits is desirable. Make it part of your internal dialog.

The Econowise of course embrace discipline, deferral, and discernment. We could further distinguish between these two types as those who spend all or more than they make (spendthrift/Consumerati) versus those who spend less than they make (thrifty/Econowise). Their cousins are the Insatiable and the Prudent, respectively.

Cultural, social, or economic forces do not create criminals. They are criminals as a result of their own choices. So, too, debtors are created by their own choices just as financially independent people are created by their own choices.

Did You Know?

If you have worked for many years and have little or nothing to show for your efforts, it is because either you don't know the fundamentals of spending or you choose to ignore them. It may be a matter of financial immaturity—or perhaps you have just never been made aware of the fundamentals. Financial immaturity is the major reason that people do not plan for the future. Awareness is the easy part. That's the good news! The ongoing work of leading the life of the Econowise involves awareness of the debt effects, monitoring your burn rate, having a spending plan in place, and having a written plan for an endgame. For the Econowise, the endgame begins when passive income exceeds their needs and they are free to do as they wish. Please, don't misunderstand. I am not against work—just against forced work due to being a slave to one's desires.

Your awareness will control your possibilities. Whatever one person can do, another can do. This sentiment was a staple of Victorian writing. Many of the financial books from that period are full of examples of successes to serve as models. Today most business writers, perhaps reflecting the market, concentrate on quick fixes rather than examples stretching over several years.

Plan, Plan, Plan

It is up to you to plan, study, and seek a wise and prudent life. If you don't know how to become financially competent, you must ask until you do know. What a terrible cost silence imposes on ignorance. A Chinese proverb says, “He who asks a question is a fool for five minutes. He who does not ask is a fool forever.”

Awareness can only create a perception of possibilities. You must still muster the maturity to take action. Being full of awareness may make you interesting to talk with—but you could still be a terrible example to follow. You must also choose to be free. The ever-quotable Oscar Wilde said, “It's better to have a permanent income than to be fascinating.”

Some people never realize that they can redirect their present incomes and become wealthy. They buy into the popular culture and ignore the wisdom of the ages. You are responsible for your choices. Recast your habits and you will change your life permanently. You may change temporarily by sheer force of will, but it will only be temporary. Habits, in the long run, will control your destiny. Let's examine how education and culture may lead you to make poor choices and how you can avoid them.

It's Your Choice, but “They” Want to Help

For merchants who are armed with psychologists, sociologists, surveys, and ad agencies, the typical consumer is no more than a cow being milked by his or her emotions. When you no longer produce the milk—uh, the payments for your excesses—you are shipped off to the bankruptcy slaughterhouse to have your guts ground into sausage and your hide made into leather bags for ad executives. Then, you are returned to the general population as an empty shell, to start the cycle all over again—unless you learned from the lessons of debt.

Have so many of us really degenerated from freedom seekers to mere cows being milked by our emotions? What do you think?

Many foreigners are amazed to learn that we do not teach saving or investing in our public schools. If we do not learn our financial skills from our parents, where do we learn them? Most people, I suspect, are self-taught—usually after realizing that what they have been doing is not working. Others will never learn.

Surveys show that American children are behind those in many developed countries in math, science, and reading but are number one in the belief that they are the best in the world. Unearned self-esteem is much like consumer credit borrowing—one day the bill comes due. Wouldn't it be better if Johnny could actually read and do math rather than just feel that he can? Won't Johnny's self-esteem be better in the long run if he bases his assumptions on hard facts rather than feelings? Won't Johnny's financial future be better if he understands the full effect of his spending? Shouldn't we teach our children to build a solid financial foundation rather than create an illusion of wealth supported by consumer credit? Can I Fast-Forward?

Søren Kierkegaard wrote, “Life can only be understood backwards; but it must be lived forwards.” Ah, I see the problem. Is it worth all the work to develop an Econowise plan? You can answer that question only by projecting forward and looking back.

Suppose you had a videotape of your future and could fast-forward to see if all the work ahead of you would be worthwhile. Can I give you a hint? If you don't change the way you think and act now, your financial future will look pretty much as it does today. But, if you take steps now, you can change the ending. Remember the thumb-worn creed, “He finished on time, because he started on time.” Begin now. Only change now can affect the end of your tape.

Your biggest investment should be in your future. Your future is enriched by applied knowledge of your daily burn rate, retirement, education, reading, and study. A definite purpose, a desire, to have a certain future must be at the center of your plan.

We often fear facing the truth about our careers and ambitions because of the effort it will require to override the debt effects. It's easier to maintain the status quo than to strive for your dreams. Are you able to change your career or follow your dreams? Or are you enslaved to bad debt? Debt makes cowards of us all.

Inaction will wear you out!

How's Being Broke Working for You?

Sometimes I hear, “That's too much work! Who wants to spend their time planning and thinking, saving, and learning to invest?” Jim Rohn mocks Joe Six-Pack with this line: “Hey, by the time I get home, have a few beers, watch a little TV, I don't have time to study, to learn—to read!” Mr. Rohn incredulously adds, “And he wonders why he is broke?!”

Let me ask you this: are you getting any rest being broke? For the most part, being poor is more tiring than treading the path to wealth. And the path to wealth is much less depressing. If you have a mind to improve your lot in life, keep in mind that inaction will wear you out!

Good Debt vs. Bad Debt

You can view the differences between good debt and bad debt as much like the differences between good cholesterol and bad cholesterol. Doctors tell us that we need a certain amount of good cholesterol but that too much bad cholesterol will eventually kill us.

We can liken bad cholesterol—LDL (low-density lipoprotein)—to bad debt, which is artery- clogging debt. Good cholesterol—HDL (high-density lipoprotein)—is akin to good debt that clears arteries and keeps you financially healthy. Part of this financial artery-clearing effect is an increase in cash (blood) flow.

I always thought that zero cholesterol was supposed to be my goal. Not so. Apparently if your HDL measurement is under 35, it's a health risk. Your total HDL rating should be 40 or 50, and up to 70 or 80 of HDL can actually protect you against various diseases.

Likewise, some people think that zero debt is best. It sounds good, doesn't it? But zero debt also means zero growth or at the most a low growth rate. Perhaps we can learn from the HDL example. If it takes some HDL to be in good physical health, let's take the mental leap that it takes some good debt to be financially healthy.

The definition of good debt is similar to that of good cholesterol. It keeps the arteries clear. Good debt keeps the cash flow running smoothly and the funds pumping. When you read the definitions below, notice that good debt is a debt on assets that produce a return above their cost. It is debt on assets that create cash flow in excess of the cost of the debt. It is not debt that kills. Remember this: when you use debt to pay for something, it is not a payment in full, but merely a claim on your future time and earnings.

good debt
. Earns its keep
. Increases your net worth or cash flow
. Secures a discount that can be converted to cash or net worth
. Creates leveraged position ($300 out, $400 in monthly)
. Examples: debt for real estate at a safely leveraged level, debt for education that can be applied for a return of capital, debt for a business you are competent to operate

bad debt
. Is typically for consumption
. Decreases your net worth or cash flow
. Examples: Car loans that rob your retirement fund, continuing credit card debt, living on student loans, furniture loans, loans for rapidly depreciating items, loans for parties, weddings, or vacations be applied for a return of capital, debt for a business you are competent to operate Bad Debt. Bad debt is money owed for trinkets, nonessential essentials, an excess of items, and other consumer junk. For example, a nonessential essential co for a Lexus, without the commensurate cash flow. It is true that you need a car, an essential, but you don't need a car that costs $599 per month. See Chapter 8 (“Driving Your Life Away”).

Generally, credit cards, unless paid in full monthly, involve bad debt. Approximately 50 percent of Americans make the minimum payment or don't pay their balances in full each month. Certainly we need clothes, cars, washers, dryers and many other consumer items we sometimes charge. Bad debt usually begins to pile up when we allow emotional spending or spending without regard to consequences. Without a spending plan in place and clear guidelines, we accumulate bad debt quickly.

What People are Saying About This

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This is an excellent primer on a very important topic.
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Meet the Author

Jon Hanson is a twenty-four-year veteran of the real estate business and now a full-time author and speaker on topics of personal finance.

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