Good Debt Vs. Bad Debt – Episode 078

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler, and No BS Money Guy, Todd Strobel. Hey everybody, welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, lucky enough to have bestselling financial author and our co-host, Kim Butler with us today. Welcome, Kim. Thank you, Todd. Happy to be here. And today we’re going to be, once again, talking about some questions that we’ve received from our listeners or viewers or however you want to call them, podcasters. And we’re talking about the idea of debt, I guess, good debt versus bad debt and when

[00:49] to pay, when not to pay, and questions like that. So start us there. And also when to prepay, and that’s where I would like to start is the question that came in was I already have a 15-year mortgage and I’ve listened to you guys and realized that a 30-year mortgage is a more effective financial tool, but I’m already in, so what do I do? And the answer is stay the course. Without a doubt, unless you feel like you have other good reasons to refinance, let’s say interest rates are a lot lower or you move or something logical like that, you are really probably better off staying the course. Now, I could make a financial case for paying all the costs that it would take to get out of the 15-year mortgage and back into the 30, but what you want to be doing is realizing,

[01:40] so this is the larger question, do you prepay debt? You want to realize where you are interest rate-wise. So let’s say that you have a 4% 15-year mortgage and you’re just making regular payments on it and you also have a 4% cash value life insurance policy and you have a little bit of extra money every month and your question is, do I put a little extra in my cash value life insurance, probably whole life policy, or do I put a little extra against my 4% debt? And obviously, we purposely picked numbers that were the same. Now, we’re not taking taxes into consideration because the life insurance, of course, is not taxed and the mortgage is giving you a tax deduction. So just removing taxes from the discussion, if we assume that those two interest rates

[02:28] are the same, the freedom, the control, the liquidity, the available use of the cash value that you can truly borrow against at any time without any questions is where your dollars should go. And so that’s the whole life policy. Your extra money should go into the whole life policy because of our Clue acronym, CLUE, Control, Liquidity, Use, and Equity, and I threw freedom in there too because all of those things create freedom. Any extra dollars should go there. So if you have a 15-year mortgage and you’re lamenting the fact that you have that, don’t worry about it. Just leave it as is. If an opportunity comes to refinance, then great, you can stretch it back out into a 30, in which case that too will create extra cash flow for you every month

[03:19] because you’ve been used to a higher payment. Now you’re going to have a lower payment. And again, that extra money should go into the life insurance policy either as premium or as pay to petition. And again, I remind you that premium builds cash value also. Don’t get caught into the wrong thinking that premium is all cost and only pay to petition builds cash value. They both build cash value. So does that answer the, do I prepay my mortgage or what do I do with my extra cash or what do I do if I have a 15-year mortgage question? I believe so. So first of all, there was another show that we had done that actually sparked this question and that particular show was if I’m buying a house, do I do a

[04:01] 30 versus a 15? And y’all are welcome to check out that show. And we really showed where 30 years made much more sense. And then the additional question that came in was about the refinance question or the extra money per month question that we have. An additional question that we got that I think is another good one is that is the 30 year versus 15 year strategy the same if I’m talking about an investment property versus my home that I live in? Excellent question. So the answer is yes. It is still the same because again, your own cash has a cost. And so when you take renter’s income, that then becomes your own cash. And if you put it against a 15 year mortgage, you are now locking that cash up into this thing called investment equity, which you do not control.

[04:56] You do not have as a liquid item on your balance sheet. You cannot use it for anything you want and you cannot borrow against it. You might be able to, but we don’t want to rely our personal finances on the word might. So yes, in residence as well as investment real estate, we want to have 15 years as not the thing to focus on. We want to have 30 years as the thing to focus on. Sometimes on investment real estate is 20 years. That’s fine. That’s as long as you can get is the bottom line. That is the mortgage that is the most efficient and you can do the best with your personal finances. If all other dollars, whether they’re rentals, rental income dollars, the renter’s dollars, or your own dollars are put in a place that you can control

[05:46] that’s liquid, which is not equity. It’s just not available from the banks. And even if we go back into an era when home equity loans are very easy to get, the bank still has to say yes. And you want to put yourself in a position where your liquidity and your cash is stored in a place where you don’t have to rely on the bank saying anything to get access to it. Absolutely. I can still remember in 2008, I had a client in Las Vegas, Nevada, who was a contractor that basically did building cleaning and stuff for the big hotels and things down there. And when all of this financial crisis hits, many companies went out of business, he had a chance to really quadruple his business, but he lost all of his lines of credit for his business because of the financial

[06:31] crisis, which is probably why the other companies went out of business too, honestly. And he was able to use the cash value that he had stored in that life insurance to be one of the few people that came out of 2008 happy. Fabulous story. Yes, we have lots of clients that survived 2008 and 9 because of cash value of life insurance, because it was not restricted. And the insurance companies also, because they store their dollars reserved as a dollar for a dollar versus the fractional reserve strategy that the banks use, the life insurance companies weathered that era just fine. They continue to pay dividends throughout that entire timeframe and were largely unaffected by all the gyrations that were occurring

[07:20] in the mortgage markets and with all of the banks. And even the one insurance company that does come up on occasion, AIG, it was in trouble not because of its insurance, but because of all of the work that it did with the collateralized debt obligations in the mortgage arena. The life insurance part was just fine. And again, if you look back at some of our old shows, you can see the difference on cash flow versus net worth, because if you were lending your money, putting your money on a commercial piece of property, the equity in that property and the cash in that life insurance on a balance sheet would be exactly the same. So you would have exactly the same net worth in either scenario. Yet, if that equity disappeared as we saw it do in 2008,

[08:12] well, we actually passed the mark to market things where we would probably have taken that equity off of your balance sheet versus having it in a cash value account where it would have maintained and stayed where you could use it, huge difference on the cash flow arena, as well as your monthly expenses are much less if you’re maximizing your maturities, I believe is the term, and that’s just simply stretching that debt as long as you can practically do it. Absolutely. So this goes the same for the car loans, for the credit cards, for equipment leases and all other types of debt. Pay attention to your interest rates. And if you’ll use 8% as a rule of thumb for whether the loan is a good loan or a bad loan, so 8% less in our research forever

[09:04] and ever has been a good loan and above 8% is not so good. So if you have debt that is 8% or below, don’t be prepaying it. You’re actually better off saving that money into some form of liquid capability, typically the cash value of life insurance. However, if the debt is higher than that, then you’ll want to attack it and either get refinanced or pay extra so that you can get rid of it because it truly is a drag on the balance sheet. We realize that sometimes it’s worth it. It’s deductible in the business or it’s a necessary item for whatever other reason. But as a general rule of thumb, if you have debt that’s above 8%, you should be working on getting it paid off. And that brings up yet another good question, which is paying

[09:53] for your children’s education versus taking out a student loan, which are less than 8% by the way. But absolutely. So the student loans are fine as long as they are kept at reasonable levels and the family as a whole, both the parents and the children, understand that that is a debt out there in the future that does need to be repaid. And so if the only way to get the schooling done is the student loan, and it’s something that everybody agrees on, great. But every family has to answer the question for themselves as to first of all, is it worth it? And second of all, how much student loan debt is too much student loan debt? And we also have to realize that even if you actually pay cash for tuition, you’re

[10:40] essentially financing that with that tuition cost with your future, you could call them retirement dollars. So we do need to be aware that even if you’re not actually taking loans or getting them from the banks for paying for college, that there is a financing charge and it’s wherever that cash came from, even if it’s your own earned income, if you didn’t pay for the cost of tuition, where could that money have gone? And whatever interest rate that account is, that’s the in essence cost of that college tuition. So let’s say, for example, you have student loan debt and it’s available to you at, say, five percent and you have an awesome investment that’s at nine percent. And if you take the student loan and you

[11:26] can keep the money invested or you can put the money into the investment, then that’s a better strategy. But if you have cash sitting around at zero percent and you don’t know what to do with it, then you are better off going ahead and using that cash to pay for the tuition so that you don’t have to incur additional interest rate charges because then the one hundred thousand of actual tuition over the course of time could turn into a lot more because of the interest on top. Super. So again, not necessarily good or bad. It’s an individual circumstance and we’re kind of giving you some parameters as far as interest rates and time frames. What else should we be thinking about when they’re looking at debt versus,

[12:13] say, a whole life policy? Well, I think the actual asset that you’re buying, I use the term asset loosely, can be part of the discussion as well, because it’s certainly acceptable to take car loans as an example, mortgages, of course. And as I mentioned earlier, sometimes equipment loans. But ideally, everything else, especially in our short-term society, should be paid for. So use your credit card, but pay for it every month. And occasionally, of course, some people need to put maybe a plane ticket or something like that and stretch a payment out over a couple months. That’s not a big deal. But anything that we’re using, that we’re consuming on a daily basis should not have debt on it. Again, car being

[12:56] the exception and even the cars we have to be careful with. And you can do yourself so much good by being just responsible around the purchase of cars. We’ve got a great blog post on how to finance the cars most efficiently. And maybe we’ll cover that on another podcast. Super. Well, again, is there any other tools or websites or anything you’d like to refer to our listeners? Well, we’ve got our Busting the Interest Rate Lives book. And if it’s not on Amazon, it will be there shortly. There is a audio version as well as Kindle version, as well as a physical book. And it covers a lot of the things that we’ve been talking about today, both education, mortgages, car financing, prepaying debt, etc. And so I would encourage

[13:43] anybody to get a hold of that. And it’s a fun book because it follows a high school student through his whole life. So there’s a little bit of a storyline with it. And if you’re not interested in the book for yourself, it might be a fabulous present for a high school or college student to help them get their financial education up to par. Super. Well, Kim have really appreciated our time together today. This is once again No BS Money Guy Todd Strobel for the Prosperity Podcast saying take care everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.