Wednesday, May 2, 2007

How To Avoid Debt: Stop the Debt Spiral before It Starts

The best way to avoid debt is to question why you are considering debt and reckon your happiness in both the debt and no-debt alternatives.

Let's say you want to buy a $200,000 house. The best method is to pay cash. Who has that kind of money? You do, and more, if you are willing to take a mortgage for it, because you pay the full price plus interest eventually. Right now, setting aside fees, etc. to simplify the example:

  • Buying a $200,000 house with cash costs you $200,000.
  • Buying a $200,000 house with a 15-year mortgage costs you $300,000 ($100,000 interest).
  • Buying a $200,000 house with a 30-year mortgage costs you $440,000 ($240,000 interest; the interest exceeds the house price).
Why would you want to pay $10 for a $5 sandwich, $40,000 for a $20,000 car, or $440,000 for a house that is only worth $200,000?

Joe Consumer orders gadgets online or buys trinkets while traveling to save a few bucks of sales tax but then spends an extra quarter million dollar surcharge (mortgage interest) on the biggest purchase of his life.

Yes, inflation and tax deductions slash the pain but not the point.

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