Bloggers regularly post the amount of their debt. $25,000 or more of non-mortgage, non-business debt is a number I have seen several times. There is a great personal cost of having consumer debt - it can significantly reduce one's ability to become wealthy.
Let me illustrate with two hypothetical 20-year olds, I. M. Poor and Weeb E. Rich. To make the example simple, I assume that I. M. and Weeb both have similar pay throughout their lives and spend all of their monthly income on living expenses (housing, food, clothing, transportation, etc.) except for $500. The only difference is that I. M. Poor has $25,000 of non-mortgage debt, to which he makes the minimum payment of $500 at 24% interest. Weeb E. Rich has no debt and puts the $500 per month into a savings account. Let's track their financial journey to retirement.
| Financial Status | |||
|---|---|---|---|
| Category | Weeb E. Rich | I. M. Poor | |
| Debt (24% interest) | N/A | $25,000 | |
| Monthly Saving (Debt) Payment | $500 | ($500) | |
| Time to Payoff Debt | N/A | 45 years | |
| Total Debt Payments | N/A | $270,000 | |
| Value of Savings (8% Return) after 45 years | $2,637,270 | 0 | |
When I first did this calculation, I was amazed at the result. I agree that $25,000 of debt at 24% interest may be extreme. Also, each person's situation is different and may result in significantly different or lower numbers. However, the fact remains that consumer debt significantly reduces one's capability to create wealth.
Even if one's debt payment is less that $500 per month, it can significantly reduce one's ability to build wealth. The table below shows total cost of payments and the lost savings (at 8% return) from from having monthly debt payments of $100 to $400 for 45 years.
| Monthly Debt Payment | Total Debt Payments | Value of Lost Savings |
$100 | $54,000 | $527,454 |
$200 | $108,000 | $1,054,908 |
$300 | $162,000 | $1,582,362 |
$400 | $216,000 | $2,109,816 |
For me, the value of lost savings is too high and I try to be free of consumer debt. This calculation is also causing me to seriously consider eliminating my mortgage debt.
For more on The Practice of Personal Finance , check back every Wednesday new segment.
This is not financial advice. Please consult a professional advisor.
Copyright © 2007 Achievement Catalyst, LLC
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