Debt Freedom: A Personal Finance Startegy

cutting loose by SqueakyMarmot on Flickr!I hear from a lot of readers who avidly follow Dave Ramsey. Many of them have taken his Financial Peace course, some got on board with his Total Money Makeover, and others avidly follow his radio show. Virtually all of them are strongly committed to complete debt freedom as a goal and they’re throwing everything but the kitchen sink at that goal.

And I think that’s awesome. Here’s why.

First, it’s a goal-oriented personal finance strategy. People following Dave’s plan have a very clear goal in mind – debt freedom. That’s the big goal they’re moving towards and it’s always in sight. Not only that, it automatically comes with short-term goals embedded inside in the form of the debt snowball – each month, you’re making it your goal to come up with a nice big extra debt payment.

Second, it’s very psychologically powerful. The entire plan has you paying off debts in a pretty regular order, and each one of those debts provides a great positive psychological boost. “The car? It’s paid off.” “My student loan? It’s gone.” It feels good to be able to say these things.

Third, complete freedom from debt is a very healthy personal finance state to be in. Debt freedom gives you the maximum possible freedom to do whatever you want with your income. You’re no longer beholden to mortgages or loans – your choices with your income (once you’ve paid basic bills and bought food) are entirely up to you. You have the freedom to make radical career changes, start investing rapidly for a big dream you’ve always had, or take advantage anything else that might come along.

But there’s a problem with this flowery picture. Whenever you start talking about absolute debt freedom, though, you introduce some more difficult questions along the way. When does this goal take priority over saving for retirement? When does it take priority over investing for other goals? Sometimes, debt freedom isn’t the most financially lucrative choice.

Right now, my wife and I are trying to make some difficult choices about where our financial path should lead. After our recent success in eliminating debt, we have just a single student loan and our mortgage to contend with, with the student loan locked in at a higher rate (but with a much smaller balance). Our shared goal is to eliminate that student loan, but after that, we’re not sure.

Our goal is not debt freedom, though there is appeal to it. Our goal is to eventually buy a piece of land in a very rural area, build a nice house on it, and basically have a very small-scale farm. We want a very large garden and have discussed raising chickens and possibly a few other animals on that land.

Our home mortgage is locked in at just below 6%. Following the strict debt freedom path, we should pay off our home mortgage as quickly as possible, then start saving for the “farm.” This effectively means that we’d be earning a guaranteed 5.875% return on our investment in our mortgage.

Alternately, as soon as we’re debt free besides our mortgage, we could begin investing. Investing gives us the possibility of a return much higher than 5.875% on our money, but there are no guarantees and we’d also have to pay taxes on the gains, meaning we’d have to earn 7.5% (at least) on our investments to match the value of putting the money into our home mortgage (which is essentially a tax-free “investment”). It also gives us the flexibility to do other things along the way.

So, which is it? Both paths have powerful arguments, but for us it mostly comes down to risk: are we willing to tolerate some risk along the way on our path towards this dream home of ours? This is something we’re still piecing through.

The real point here is that while debt freedom is an admirable and powerful goal, make sure that it doesn’t actually work against other goals you might have. When you start to see some real success in eliminating your debts, spend some time asking yourself what you really want. You may simply want the psychic feeling of debt freedom, in which case continuing to rail against your debt is clearly the best idea. On the other hand, you may want other things, such as a new house, an new career, or a well-cushioned retirement, in which case investing once you’ve got the debt under control may be the best idea for you.

No matter what, though, debt repayment is never a mistake. It will always improve your financial situation and it will always reduce your personal risk. The real underlying principle here is spending less than you earn – the one thing that you can do to ensure long-term financial success – and debt repayment basically forces you into that philosophy.

If you’re deeply involved in a debt repayment plan, spend some time figuring out your big goals besides being free of debt. It may turn out that at a certain point it’s more sensible for you to do something different with your money, but always remember that the fact that you’ve reached this point and are making this decision is a great success. You’re already moving away from the traps of debt and overspending.

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