The Total Money Makeover: Debt Myths

This is the second of twelve parts of a “book club” reading and discussion of Dave Ramsey’s The Total Money Makeover, where this book on debt reduction is teased apart and looked at in detail. This entry covers the third chapter, finishing on page 51. The next entry, covering the fourth chapter, will appear on Wednesday.

ttmmDave Ramsey is probably the loudest proponent out there of the “debt is bad” mantra and he makes the case for it loud and clear in this chapter. In his eyes, outside of a home mortgage (and that one should be paid off ASAP), all debt is bad.

I agree completely. The only problem comes in when this mantra is taken too far and overlooks the benefits of establishing a positive credit history. The positives of being debt free heavily outweigh the negatives of being heavily in debt, but being debt free doesn’t mean you should sacrifice a good credit history along the way. Let’s talk about this whole picture.

Not Using Debt Is Ridiculous?
The usage of debt for major purchases is definitely ingrained in the American psyche. At virtually every retailer you visit, there’s an offer to sign up for a credit card or finance the purchase you’re about to make. It seems so natural that many people assume it is natural. On page 19, Ramsey mentions this phenomenon:

[I]n the last several years, I have found that a major barrier to winning is our view of debt. Most people who have made the decision to stop borrowing money have experienced something weird: ridicule. Friends and family who are disciples of the myth that debt is good have ridiculed those on the path to freedom.

Given that financing usually means paying substantially more for the item over the long run, anyone who chides you for paying cash is actually chiding you for paying less – ludicrous, in other words.

My big issue here is how to deal with people who make comments like this. Whenever I’ve faced situations like this, I’ve found that explaining the truth doesn’t work – I’m usually met with a vacant, wide-eyed look that clearly indicates that the other person has no idea what I’m talking about.

Instead, my approach is to simply smile, nod, and do my own thing. Over the long run, my bank account will prove me right in paying cash as often as possible.

Risky Debt
On page 21, Ramsey argues that simply possessing debt is a risk, let alone paying it late:

My contention is that debt brings on enough risk to offset any advantage that could be gained through leverage of debt. Given time, a lifetime, risk will destroy the perceived returns purported by the mythsayers.

This is one of the most powerful arguments against debt, in my opinion. Most of the time, when people make the case for taking on debt, they make assumptions that involve a perfect, trouble-free life.

Sure, it’s easy to make a $400 a month payment given your current life situation, but what happens if you lose your job tomorrow? Or in a year? What if you suffer a major illness? What if your marriage falls apart? What if you get married? What if an unexpected child arrives?

Forecasting payments into the future can be smooth but the realities of our lives are quite bumpy, indeed. Lives don’t follow the smooth lines and curves of a debt repayment schedule, and saddling our lives with such lines and curves might enable us to get a car a bit earlier, but it also adds a lot of stress and worry if our life zigs when we expect it to zag.

Respect your complex, beautiful life and avoid unnecessary debt.

Relatives Shouldn’t Be Lenders
One of my biggest personal standards for money is to not lend money to family. If I decide to give someone a helping hand, it’ll be in the form of a gift, not a loan. Ramsey makes the case on page 26:

Hundreds of times I’ve seen relationships strained and sometimes destroyed. We all have, but we continue to believe the myth that a loan to a loved one is a blessing. It isn’t; it is a curse. Don’t put that burden on any relationship you care about.

Do you love your mortgage lender? How about your credit card company – do you look forward to getting together with them at Christmastime? Ever felt like inviting your car salesman to your New Years’ party?

The reason is that the lending/borrowing relationship doesn’t mix well with great interpersonal relations. If you borrow money from someone, you suddenly have a financial obligation to that person. You have to pay them back or incur some sort of retribution.

Retribution? That’s not exactly a concept that mixes well with close relationships and family events. Nor should it. No one wants to spend time with a person that’s demanding money from them. Thus, after a loan between friends or loved ones, it’s natural to expect that relationship to decay in some way.

No relationship is worth that decay. If you’ve decided that you really must help someone out, make that help into a gift, not a loan.

Look Good or Be Good?
On page 33, Dave digs into the difference between putting up appearances and actually having something to back it up:

Having been a millionaire and gone broke, I dug my way out by making a decision about looking good versus being good. Looking good is when your broke friends are impressed by what you drive, and being good is having more money than they have.

Something has always troubled me about the phrase “fake it ’till you make it.” I can understand it in some situations, where you have to put up a very polished front in order to further your career.

The problem comes when “fake it ’till you make it” becomes a life philosophy. If you find yourself leasing a BMW so that you can “fake it” and put up an appearance of being financially affluent when you’re really not, you’re entering into a trap.

Sure, you might be able to put up an appearance of “making it” with that purchase, but your income will be devoured by that car instead of being able to take advantage of other opportunities. In three years, you’ll have nothing in the bank and a car that just went off lease.

Instead, if you “fake it” a little less, buy a low end car and make it look as nice as you can, you can build up that bankroll, build some security, and eventually purchase that car.

You might be able to “fake it” now, but if you want to “make it” sooner, you’ll tone down on the fakery and keep yourself out of debt.

On Buying a New Car
On page 37, Dave makes a case against buying a new car:

A good used car is as reliable or more reliable than a new car. A new $28,000 car will lose about $17,000 of value in the first four years you own it. That is almost $100 per week in lost value.

I understand where Ramsey is coming from, but it doesn’t take into account several factors.

First, the only cars that depreciate like that were junk to begin with. If you have a car that depreciates 70% in the first four years, that car has a very poor record for long-term reliability. Reliable cars simply do not depreciate that fast.

Second, the first four years are the most worry-free for a car. During that period, they’re under warranty, meaning if something goes wrong, it doesn’t come out of your pocket. Once that warranty ends, you’re on your own. It’s during that warranty period that you can figure out whether the car is actually reliable or it’s not without a cavalcade of big bills.

Third, in a down economy, there are huge incentives to buy new. Sales, rebates, and other offers pop up all over the place, some of them impressive. There are often tax breaks for new car purchases as well, passed by Congress in a short-term effort to boost spending.

I am not saying that buying new is better than buying used. Instead, I am merely saying that it is a mistake to automatically exclude a new purchase, particularly if you can afford it.

Ramsey overstates his case here, though I understand why he does it. A forceful case on behalf of a good principle is a great tactic for convincing people of the principle. I do agree that buying used is often the best deal when buying a car, but to ignore new cars does the buyer a disservice.

Mortgages and Credit Cards
On page 39, Ramsey talks about why you don’t need to build credit to get a mortgage:

You will need to find a mortgage company that does actual underwriting. That means they are professional enough to process the details of your life instead of using only a Beacon score (lending for dummies). You can get a mortgage if you lived right.

Ramsey’s absolutely right here – you don’t need credit to get a mortgage, as long as you have a good housing history and a good record of paying your bills on time. A manual underwriter will dig these things out. An aside: if you’re in this situation, visit your local credit union first. They’re more likely to do manual underwriting.

The problem here is that a mortgage is not the only avenue through which good credit can help you. One’s credit score is used in lots of ways: determining insurance rates, aiding in many job application processes, and so on.

That’s why I think limited use of a credit card is actually a good thing. Leave the card at home most of the time. Only use it for specific purchases that you would otherwise make, like gas or groceries. Then, at the end of the month, pay off the balance in full, which should be trivial since you’re not buying more because of the card.

This accomplishes the big goal of improving your credit score without incurring debt. Having a good credit score improves your hiring chances and makes you eligible for better insurance rates, putting money directly in your pocket. Later, if you do get a home loan, you can simply trash that card if you so with.

If you’re already doing that, you might as well choose a card that helps you in other ways. For example, if you’re buying a card just to buy gas on to help your credit, get the Visa or MasterCard available from your gas station chain of choice (like BP). That way, you’ll get rebates on the gas you buy along the way – another way to save.

The trick is to simply leave the card at home. Don’t use it for any other purchases besides the ones you plan in advance, like gas purchases, and keep it somewhere safe outside of those opportunities.

Do you have any other thoughts on the third chapter of The Total Money Makeover? Please share them in the comments – and feel free to respond to any of my impressions as well. After all, a good book club is all about discussion!

On Wednesday, we’ll tackle the fourth chapter – Money Myths: The (Non)Secrets of the Rich.

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