SMS 174 – Open Ended Debt Solution

The Open Ended Debt Solution

We should avoid debt at all cost, but in life things don’t always go as planned and debt becomes unavoidable. Also for things like buying a house and sometimes getting an education require debt based on the timing in life and the natures of their significant cost.

Whenever you enter and agreement to borrow money and repay it you need to be strategic

Borrowing money for education:

This one is hard as you don’t know how much you will make so it becomes hard to access how long it will take to repay. The terms of the loan state when interest will be charged and when you need to begin repayment, but for the average person this is an open ended debt that you hope to repay some day in the future.

Borrowing money for a car:

When you borrow money for a car at first glance it appears to have an end date, but in the big picture of owning cars for most it is not. Once you own a car there is generally no going back to not owning a car, you become a car owner for life.

How car buying usually happens:

  • You buy a car based on the monthly payments you can afford and this is based on interest rate and term
  • Assume this car payment was the most you could afford and the term was over 8 years
  • Assume this dramatically reduced your savings rate to which you were only able to save the down payment for your next car at the end of 8 years

How car buying should happen:

  • You buy a car based on your ability to repay the loan over 3 years
  • You drive the car for 8 years
  • At the end of 3 years you continue to save your car payment the 5 yeas you don’t have a payment
  • At the end of 8 years you buy a better car that will last 10 years but still repay over 3 years
  • At the end of 3 years you continue to save your car payment for 8 years
  • At the end of 10 years you pay cash for your next car

Borrowing money for a house:

Based on the significant cost of a house borrowing money is a reality for most, if we saved up and paid cash two things would happen. First we would be chancing the housing market in that for most people the house would increase in cost faster than your savings rate and you would never reach your goal. Second, by the time you saved up enough for a house your hosing need would have changed.

The open nature of a mortgage is kind of sneaky:

  • Approved based on monthly carrying costs, assume 25 year amortization
  • Agree on a term for interest rate, assume 5 years
  • At the end of the 5 years you can renew your interest rate and amortization
  • Based on interest rates people generally adjust the amortization to get the monthly payment that they are comfortable with, this could be another 25 years.

How a mortgage should be repaid:

  • You should be approved based on your ability to repay the mortgage in the year you plan to be mortgage free
  • The year you plan to be mortgage free should be based on all of the other life events such as educating your children and when you plan to retire.

The problem with open ended debt:

  1. You spend your time solving your past rather than focusing on your future
  2. You become okay with debt 
  3. You have no sense of urgency
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