Editor's note: This article first ran in September of 2013.
According to David Graeber, author of the book Debt: The First 5000 Years, the term ‘freedom’ was originally associated with freedom from debt. It translated into “return to mother” because when debtors fell into arrears badly enough, their children were taken away from them.
Today, we are overly comfortable with debt. In this TEDx talk, I contend that we need to start hating it again. While it plays an important function in our economy when used responsibly, too many people use it irresponsibly.
The often quoted household debt-to-income ratio, which recently hit an all-time high of 163.4 per cent, doesn’t tell the whole story. It doesn’t factor in the effect of lower interest rates. That makes a difference because $100 per month supports a lot more borrowing in a low rate environment than a high one, with no additional strain on cash flow.
Younger Canadians should expect a ratio north of 200 per cent to be quite normal as their incomes are low and they are entering a period of their life traditionally associated with many big expenses: weddings, houses, children, first reliable cars, etc. Older Canadians should have ratios of 0 per cent. It also doesn’t speak to the other side of the balance sheet: assets. Household net worth has been increasing.
But are these changes good news or bad news? When I talk to everyday people, they seem to be struggling more and more. Income inequality could explain the reconciliation of data. The rich could be getting richer, and the poor could be getting poorer.
When I was a financial adviser, there were two traits that separated those who seemed to be naturally good with money from those who weren’t, irrespective of their grasp on investing and financial planning . They ran a surplus, and they knew that you earn interest, you don’t pay it.
In the talk, I give the example of the cost of a $35,000 car varying from $34,000 to $43,000. Using a high-interest savings account, you could save just a bit less than the total price with the difference being made up by earned interest. Financing via a seven-year loan could incur $8,000 in interest charges. Given that the average person will own nine cars in their lifetime, a household requiring two cars could spend the equivalent of 4.6 cars in interest expenses. But what tends to happen for those who save up in advance is that they spend less and buy less often. Parting with cash from your bank account is often harder than arranging financing for the same amount.
In this simple example, the choice to save up for a depreciating asset versus financing amounts to $162,000 (18 cars x $9,000 savings). If you additionally earned interest on the savings, that figure grows significantly. Forget “return to mother,” come to daddy.
Preet Banerjee, a personal finance expert, is the host of Million Dollar Neighbourhood on The Oprah Winfrey Network. You can read his blog at WhereDoesAllMyMoneyGo.com and follow him on Twitter at @preetbanerjee.