Get out of Debt! Bad advice?

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Erik T.'s picture
Erik T.
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Get out of Debt! Bad advice?

One of the most consistent answers to the question What should I do? that you will hear from Chris Martenson and many other experts concerned with this subject matter is "Get yourself out of debt! Pay it off as fast as you possibly can." While I mean no disrespect to Chris or the other experts who have offered this advice, the more I have pondered this, the more I come to the conclusion that this is really, really bad advice given current economic conditions. The purpose of this thread is to explain my rationale and solicit feedback and discussion. Someobdy is "missing something" here. Maybe it's me and you folks can elighten me...

Before going on, let me emphasize that I am not suggesting you shouldn't worry about being in debt. You should. But I want to consider the question of paying down debt voluntarily now in contrast to a specific alternative: saving aggressively so that you could pay all your debt down from savings in the future. The debt is definitely a scary problem for all the reasons Chris and others have described. But paying it off now makes absolutely no sense in my opinion. The one exception would be any high-interest rate debt such as credit cards that charge 20% APR and the like.

Let's create a hypothetical example to evaluate the relative merits of different courses of action. Suppose that Joe & Mary owe $250k on their mortgage.. They are concerned that in the coming crisis this debt will be their undoing, and after watching the Crash Course they feel inclined to cut back on their expenditures (definitely a good idea) and use all available spare cash to aggressively pay down all their debt. They work out a plan to eventually get completely out of debt by aggressively over-paying their installments.

Steve & Susie are in exactly the same financial situation and share Joe & Mary's concerns. Like the other couple, they cut back on expenditure as much as they possibly can. But instead, they decide to continue making regular payments on their debt,  and open a new savings account where they are going to aggressively start saving. They figure they can always liquidate that account to pay off their debt any time they like, but they figure "cash is king", and prefer to hang onto all the dollars they can for now. Their goal is not to pay off the debt, but to build their savings account to the point that its value equals their debt, putting them in a position to pay themselves out of debt any time they like.

First, let's understand the trade-offs and costs between the approaches. The argument against the Steve and Susie's solution is that they will be getting next to zero interest from their new savings account, but will still continue paying higher interest on their existing loans. A true statement is that if no other variables change, it will take Steve & Sally more time than Joe & Mary to get to an equivalent debt-independent outcome. However, they will be holding onto the cash, and thus keep their options open to change the plan if the world around them changes. Once Joe & Mary's excess payments are made (to reduce debt), they can't get that money back from the bank. Steve and Susie are instead setting money aside to pay off the debt, but not acutally paying down the notes. In finance parlance, Steve and Susie are paying an optionality premium. That premium can be calculated by multiplying the difference between the interest rate paid on the new savings account and the outstanding loans by the balance of the new savings account. That amount is their annual optionality premium cost, and will start low and increase over time in proportion to the size of the savings account. What they get for this premium is the flexibility to spend the saved money on something other than debt repayment if their outlook changes.

I contend that Steve and Susie made the smarter choice, unless the interest rate delta is really high (at least 10% rate delta). Now let's consider why.

One of the ideas already under consideration is the cramdown which means that exsisting mortgages would be re-written by the courts or legislature to have a lower principal balance. This is the free give-away to the irresponsible that has so many of us responsible types up in arms. But whether we like it or not, it's under serious consideration. Suppose that both couples have managed to scrape together $125k. Joe and Mary used it to pay down their debt by 1/2. Steve and Susie kept the money in their savings account. Then a national cramdown provision is announced that both couples qualify for. It gives everybody a 40% cramdown. Joe & Mary had paid their mortgage down from $250k to $125k. After the cramdown their new mortgage balance is $75k. That feels much better than $250k for sure. But Steve & Susie are still holding the $250k mortgage. After the cramdown they owe $150k, but they have $125k saved up. They are $25k away from financial freedom, but Joe & Mary are still $75k in the hole.

Another entirely plausible scenario that I just saw proposed in a news article the other day: Your mortgage backs a bond that someone somewhere owns. They can only get about 20 cents on the dollar for it in this market, so they are stuck holding an asset (indirectly, your house) that they really don't want. So they effectively reverse the securitization process, and send you a letter saying "Hey listen, if you can come up with 60% of what you owe on this mortgate and pay it all at once, we'll take it and give you a receipt as paid in full". This is a different socio-political scenario, but the economics are the same as the previous example.

Another scenario is what I call "walkaway optionality". In the United States, all residential mortgages are, by law, non-recourse loans. That means that if Steve & Susie default, the bank can take the house, but they can't touch that new savings account. If things really go to hell and both couples' houses are only worth $100k each on the open market, Bob & Mary still owe $125k against that $100 asset, or $25k of negative equity. At first glance, Steve and Susie appear to be much deeper in the hole, with $150k of negative equity. But Steve and Susie can legally just walk away from that house and buy the one next door for $100k cash, and still have $25k leftover. They key point here is a lot of people seem to think that being "way underwater" (big negative equity) is a really risky situation for them personally. Wrong! It's a really risky situation for the bank, not the borrower.

But these aren't even the scenarios that I worry most about. What if this situation really goes down the tubes, to the point that there are widespread defaults across the nation. We're already very close to that, and this next big wave of Alt-A rate resets could very well put us over the edge. In that situation, there would have to be some sort of stay on foreclosures until the situation could be sorted out. Joe and Mary will get one thing and one thing only out of those aggressive pay-downs: The right to honestly say "We were the responsible ones through this. We paid the bank back when nobody else did!". But everybody else who didn't act responsibly got to keep their house too. Steve and Susie on the other hand have plenty of cash (or gold) on hand to deal with day to day life during what could actually be a sovereign reorganization of the nation. They are still poised to pay down that debt any time they want if the situation dictates.

An additional benefit of the Steve/Susie approach is that they have the option of holding some or all of the savings in the form of gold bullion instead of a savings account. In past years one would argue that the gold pays no interest, but neither do savings accounts (practically speaking) these days. Now imagine a really, really serious SHTF outcome where the financial system is in complete shutdown, there is chaos in the streets, the rule of law has given way to "street justice", and the country is in complete disarray. If Steve and Susie have 125oz of physical gold bullion, they can live on it for a very long time even if paper money becomes worthless, and they can use it to get themselves and their loved ones out of the country if it comes to that. On the other hand, Joe and Mary are dead broke, can't buy food, and have only the satisfaction of being able to say "We were the responsible ones who paid off our debt". That and some of Steve & Susie's gold will buy them a cup of coffee.

I can only think of two reasons that Joe & Mary's approach (recommended by Chris and many other experts) would be better. The first is that if the financial system continues to basically function normally and we get through all this without much more economic turbulence, Joe & Mary didn't pay the optionality premia whereas Steve and Susie did. But if you think the financial system is likely to just continue functioning normally you wouldn't be reading this to start with. The second reason (and it's a very real one) is that people in general are notoriously terrible at financial discipline. Steve and Susie's plan won't work if they become tempted by a growing savings balance to spend the money on something else. But if you can overcome the discipline issue, my contention is that paying down your existing low-interest rate debt now is a really, really bad idea. Have I missed something?

Erik

 

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Re: Get out of Debt! Bad advice?

I don't know if anything has been added to the Crash Course on this subject since I took it last summer, but I imagine there and elsewhere the injunction to get out of debt was not anticipating a deflation.

Under today's circumstances, indeed, the best thing to do is buy useful assets, perhaps even going into debt to do so (if you can get a loan), with the dollar relatively strong and so many debtors having to dump assets for a song. Paying down debt right now beyond the minimum seems to be paying more than you need to. After all, when it was borrowed the dollar was probably worth less.

(Actually, not everyone is still giving the same get-out-of-debt advice these days. Mike Ruppert has always given that advice, but the last I read he was saying if he still had debt today he'd seriously consider defaulting on it. Then again, he's a really hard-core doomer who thinks total system collapse is imminent.)

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Re: Get out of Debt! Bad advice?

Great post, Erik. Very well-written and easy to process.

I also have kinda been coming to the same conclusions myself.

Ethically, the right thing to do is pay your bills in the end. Walking away from an underwater house while buying another house for its "real" value is pretty unethical - but if you consider that the whole mess we're in is due to some very unethical, or at the very least, irresponsible, behavior of banks and institutions, one has to wonder if, at least in the economic world, ethics has been completely redefined.

I agree that having money, or gold, in some sort of savings gives you way more flexibility than having no savings but owning your house outright. I'd also be willing, as you mentioned, to pay a little for that increased flexibility.

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Re: Get out of Debt! Bad advice?

 

Thank you, Erik, for this excellent analysis.  I've been wondering the same thing.  Another factor is that since the dollar is highly likely to be devalued, dollars paid on loans 5 years from now will be worth less than they are today.  In the same way that governments inflate themselves out of debt, waiting for the dollar to be devalued, then paying down the debt is one way to meet one's ethical obligation, while still defacto paying a more realistic price for one's home.  In the meantime, one can hold gold with the money saved, and sell it for an increased value as the mortgage payments become due.  As you pointed out, one still retains optionality with this strategy.  Having cash or gold reserves increases one's ability to respond to changing conditions.  I believe this will be key to surviving these tumultuous times. 

Thanks for shining a light on this.

 

 

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Re: Get out of Debt! Bad advice?

Erik,

Great post and I couldn't agree more with your observation of this situation. In fact, my wife and I have been employing the strategy of your hypothetical Steve & Susie with our student loans. Last year we opened a GoldMoney.com account to serve as our savings account (in addition to purchasing and holding bullion ourselves). Though we are sure to experience large fluctuations in the value of our savings account (as the price of gold fluctuates), I believe in the end that the account will preserve our purchasing power better than a typical savings account would. My strategy is a simple one. I see two likely options for government in dealing with this financial crisis. The first is to move the "toxic" private debt to the public sector, via bailouts, and pay it down with massive inflation. In that case, if gold holds its purchasing power relative to the inflated currency, our student loan debt would become relatively cheaper in the future, given that the nominal value of our debt would stay roughly the same but the value of the dollars that it is denominated in would drop. The second option for the government is to abolish the toxic debts and start over. In which case our country experiences some form of hyper-deflation and daily life becomes a whole different ball game. If that were to happen, I wouldn't be worried about paying the student loans. I would be worried about physical survival. Having a "savings account of gold" in that situation might be the difference between life and death. 

Having said all that, I do worry about an unforeseen bear market in gold, or Fed intervention in the gold markets, ruining our plans. Reading your post made me feel better about our decisions. Thanks for sharing.

Jeff 

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Re: Get out of Debt! Bad advice?

Sorry, I didn't see c1oudfire's comment and mine is redundant. Besides, they said it much more eloquently than I did....Jeff

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Re: Get out of Debt! Bad advice?

What if both couples lose their source of income?  What do they both have govt. jobs or something? 

Back to the experience of ancient China, one reason the Chinese culture pushes education isn't for the potential opportunities out there in the entrepeneurial world, they push education because it helps to secure govt jobs, the SAFEST jobs during times of trouble. 

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Re: Get out of Debt! Bad advice?

That was exactly what we did in late 2004. We re_financed our house at 4.75% (interest) and pull all the equity invested in gold.

If there will be hyperinflation, it will wipe out the debt. If there will be a deflation as now, we are able to buy a complex of apartments (for future income) from the equity.(we didn't buy yet since housing will go down more as long as there are more lay offs). If our house is "under water", I don't ask, but order the bank to lower either the principle or interest like our neighbours did. (bail me out)

If the finance system collaps, we don't need a house, we need gold or cash.

Will it collaps? Mr. Martinson said yes!!

Therfore, let's not worry about the debt in your house, You need minimum of 3 month cash and food in hand first.

Teach me if I am wrong.

 

 

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Re: Get out of Debt! Bad advice?

I have a feeling that Obama may be worse than Bush by creating a bigger government which supress the self healing function of the free market . None of what he did will help the fundamental of the economy.

This time, it seems, will be worse than the 1930's.

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Re: Get out of Debt! Bad advice?
kennyq wrote:

If the finance system collaps, we don't need a house, we need gold or cash.

 

If the financial system collapses, you will need food and drinking water, and a house might be more useful to you on the short run than gold.

 

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I would be royally Pi$$ed if this cram down happened.

 

Many years ago we (wife and I) bought a house that we could afford. It was a small place that had a small lot. I have made the morgage payments every month and in 2-3 years it will be paid for. All during this time I am watching irresponsible people around me buy $600,000 houses when they could only afford a $200,000 house. these are large places, pool big yards - all the nice stuff. So when (if) this mortgage cram down happens they end up with a big house and I have my small house that we end up paying the same for. I will be pissed.

 

I am sure that I am not the only one that does not want to pay for someone else's irresponsible behavior. I don't care if a bank goes belly up or the homeowner is on the street. They both deserve to lose.

 

Ken

 

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Re: Get out of Debt! Bad advice?

The only reasons I see to avoid debt are...

1) freedom - I'm currently stuck with a huge mortgage on a house I'd rather not have.  If I didn't have it, I'd feel less stress, I'd be able to travel for a year, scope out places in costa rica or new zealand, have more equity to put on land in a foreign country, etc.  

2) no claim on my assets - Erik, you mentioned that mortgages are non-recourse by law.  Is that true?  I was talking to a lawyer recently about repatriation and offshore protection and he said lenders can come after all my assets if I walk from the house.  I'm in no danger of needing to walk, but if total collapse hits in the US I want to be out of here and don't want any bank being able to pursue my assets.  If you're right and all they can do is get the house, I don't need to hedge this risk...very cool!

If #2 isn't totally true and they can come after assets, then the advice to get out of debt in deflation is great.  Income dries up in deflation.  You lose your job.  Capital investments decline.  Dividend income disappears.  So it's the simple issue of cashflow (income - costs) that says it's very prudent to be out of debt.  Debt financing is a constant outflow, while inflow is risky, fluctuating, and tends to drop in deflation.    

 

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Re: Get out of Debt! Bad advice?

Like so many things, the answer is "it depends".

 

I'm a financial advisor who works closely with hundreds of people. One of the things I do is help them with budgeting. A standard strategy I do is have people list out their fixed expenses each month: what part of their income is already committed. You'd be shocked how much of people's income is already spent on debt service before they have a moment's choice.

There was a wide-spread belief out there that the future was going to be so much better that it could handle paying for current consumption then, plus interest. It turned out to not be true: the future not only has less income, the future has its own expenses to boot! Being out of a job and trying to pay off car loans or credit card debt or even student loan debt you ran up back when you were MORE affluent is a real bitch.

I counsel people to pull together an emergency account that can handle three to six months of their living expenses, including debt service on existing debts. This is a mixture of what you're suggesting, for much the same reason. But after that, no, I don't want them to stay in debt. Perhaps a mortgage, but who has mortgages just consisting of acquisition debt anymore? Now-a-days it's really a car loan (being paid over 30 years) or a draw to pay off old credit card bills (long since forgotten) or a draw to fund some kid's over-priced education. Youjust can't tell people to keep their debt, you've got to counsel moderation in all things.

Another thing you're neglecting to consider: in repaying your debts you also necessarily have to live on less while you're doing it. This has the end result of making people not as likely to live beyond their means going forward. Over and over again I've seen people "get out of debt" by refinancing debt or by a wind-fall inheritance or some other deux ex machina method and within a year they're right back in debt again. They didn't change their habits.

I counsel people to pay off their cars and start saving for their next one.  If you don't think the future has MORE money in it than the past, why would you put your current consumption onto the back of the future?  For some people they DO have more income coming later... the car will help them get it.  For most of us, buying a car on debt is just wrong.  We need to cut that out.

The other really reprehensible debt are the student loans.  They make it so easy to sign yourself into debt slavery!  Because you can't discharge them in bankruptcy the student loan lenders (including that bitch Sallie Mae) are all too happy to let you capitalize interest and pay back over 30 years or more!  I have three clients paying on Sallie Mae loans in their sixties.  This is a constant cash outflow that is just sucking their budget dry.  Only a fool would take the minimum payment schedule they offer.  But there are a lot of fools out there.

No, I think we have to keep the short answer clearly on "get out of debt".  If you want to quibble we can talk about specific situations, but, in general, get out of debt.  Money spent on interest is money spent for absolutely no good reason.

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Re: Get out of Debt! Bad advice?

I already answered strabes in an e-mail but for everyone else's benefit, my understanding is that first mortgages on primary residences are non-recourse by law in all 50 states. A second home, second mortgage, or home equity line might or might not be - I'm really not sure and it probably varies with jurisdiction.

I am pretty darned certain, however, that if you are talking about a first mortgage on a primary residence, the lawyer you spoke with gave you bad info. Recourse is limited by law to foreclosure on the collateral, that's it. Of course it would be recorded as a default, so your credit score would be toast. But a lot of people are going to loose their credit, and in the long run I expect having a default on your record would not make you look like a bad guy. Rather you'd just look like one more innocent victim of circumstances from the 2nd Great Depression.

Erik

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Re: Get out of Debt! Bad advice?

Whether to get out of debt takes a careful analysis of advantages and disadvantages for each person's unique situation.  As Erik noted in his last paragraph, financial discipline is a big big "if".  I'm better than most and I still don't trust myself with extra cash around.

This summer I sold some equities, avoiding an eventual 25% loss if I'd kept them, and payed off my truck which brought me a risk free return on the interest on that loan greater than the dividend income I had before, before taxes.  With the title in my hands, I was going to sell it to downsize, something I plan to do still but have had bigger priorites until now. Plus it just felt better.  And with a more positive cash flow I'm putting away extra savings.  I may use that someday to pay off my home mortgage early, or I may use it for something else, or put it into something other than dollars. 

If someone can call for your debt to be paid back early though and you don't have the cash this seems where debt will really get you into trouble.  I know businesses where their credit line has been cut and this has really put them in a tight position.  Can banks force you to pay a mortgage or HELOC back early?

 

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Re: Get out of Debt! Bad advice?

Hi Erik-

   Good post!  My husband and I have also had this conversation.  Like Jageanangel, we decided it made more sense to put any extra money we can into savings.  We liked the idea of the extra flexibility that would give us to be able to use that money however the situation calls for in the future.  If we want to, we CAN use it to pay down debt later.  But if TSHTF, and we find we  need $ for some emergency situation, we will (hopefully) have the flexibility to do so.

   I agree that paying off debt is a very desirable, good thing to do.  And I appreciate the rationale that it is a good idea to pay off debt as quickly as possible in this kind of environment, in case you lose your job and your income.  But for us -not knowing for sure what the future holds- keeping our options open seemed like the more attractive alternative. 

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Re: Get out of Debt! Bad advice?
wmarsden wrote:

The other really reprehensible debt are the student loans.  They make it so easy to sign yourself into debt slavery!  Because you can't discharge them in bankruptcy the student loan lenders (including that bitch Sallie Mae) are all too happy to let you capitalize interest and pay back over 30 years or more!  I have three clients paying on Sallie Mae loans in their sixties.  This is a constant cash outflow that is just sucking their budget dry.  Only a fool would take the minimum payment schedule they offer.  But there are a lot of fools out there.

I don't know about your clients, but I'm really happy with my current student loan arrangement with Sallie Mae.  I had the foresight to consolidate in 2005 and have an interest rate well under 2%.  Given that even the fuzzy inflation numbers in recent years have lately been higher than this (and the real inflation much higher) and we will likely see some pretty heavy inflation or maybe hyperinflation in the long term, I figure I'm doing well and am in no hurry to pay it off in full. I will soon have enough savings to pay it off in full, but I'd only do that if some emergency Congress BS would allow Sallie Mae to renegotiate the terms (I wouldn't put it past them). In the meantime though, the thought that some crooked executive or accounts manager at Sallie Mae is having nervous fits every time he/she looks at my loan terms gives me that special warm feeling in the cockles of my heart  Wink.

I do understand that many others have taken out much larger loans or didn't plan their finances as carefully or just had plain bad luck, but I just wanted to let people know that sometimes the little guy does get the best of the big guys....

- Nickbert

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Re: Get out of Debt! Bad advice?

I'm working at this situation from both ends towards the middle.  I pay the minimum payment or 10% of what I have saved, when it is more (now about double my credit card minimum).  Once my savings become enough to pay off the balance I will increase my payment % to 20 or more depending on how things look.  That way I both accelerate my payments but also have cash on hand for emergencies.

 

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Re: Get out of Debt! Bad advice?

The absolute amount of interest you have to pay may be greater if you pay it back over 30 years (especially if you defer and capitalize interest occasionally during that period.)

 

Sometimes people get so excited about the low interest rate (and I'll grant you: it tends to be deductible, too) that they forget that it's better to pay NO interest than to pay low interest.

 

The cash flows are better invested in things that can help you in the future, rather than paying rent on something you already bought, in my opinion.

 

You'll figure out what I mean if you lose your job and the Sallie Mae payments don't stop. 

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Re: Get out of Debt! Bad advice?

Great post Erik. My husband and I have managed not to have any credit card or car debt for several years, and I paid all my student loans off the first time we got "money from heaven" (i.e. my performance bonuses). So, we've only been using the credit cards enough to make sure our credit rating stays nice and high (and then paying them back off immediately). Our only debt is the mortgage and HELOC. We wouldn't even have the HELOC if it weren't for the fact that we had to replace all the plumbing and electrical in our house.

We've been paying a little extra on the mortgage and almost double on the HELOC trying to pay these down; but we've recently stepped back and taken a look at that plan. 1) We absolutely don't plan to stay in this house. 2) The current loan value far eclipses the market value... through NO FAULT of our own. 3) Like Chris said "Debt is fixed, but asset value is variable".

We've recently been reducing all non-essential spending and using that money to purchase capital assets (equipment and such) that will directly help us survive on our homestead. We're now planning to go back to minimum payments on the mortgage and HELOC and put the extra money into more hard commodities. We are seriously considering (pretty much already decided) walking away from this house... either offering the bank a Short Sale or Deed In Lieu of Foreclosure, or just simply accepting the default foreclosure. The second lender is screwed, they may be able to come after us, but they can't seize our capital assets only our cash/monetary assets... which we won't have because we've cashed them out to purchase useful capital assets. The worst that could happen is that we get put into collections for 3 years... oh well, blood from a stone. Yeah, our credit will drop 200+ points with the default and collection... so that would put us somewhere just below "average", and we aren't planning on needing a loan anytime soon anyway. If the economy continues to tank and the credit bubble bursts, it's going to take several years for it to right itself... my 7 year boo boo will be erased long before then.

Do I feel bad about the possibility of commiting "jingle mail"? Just a tiny bit... I still feel morally bound to honor my agreements. But for the most part, I don't feel bad at all... 1) it wasn't my fault that home prices were completely inflated in this area. 2) I didn't go crazy and buy a McMansion, I bought the cheapest house that was a comfortable size at the time and I could easily afford it. 3) The mortgage is a business transaction... the bank accepted the risk just like I did. It's nothing personal to them, why should it be personal to me? 4) If the real estate bubble bursts, there is absolutely no way that the value of my house will ever again be at loan value... I refuse to be in this level of unrecoverable debt (i.e. paying while never again seeing equity).

The way I look at, in my circumstance, I was financially responsible and it's the banks that have created this particular problem... let them eat it because I'm not going to!

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Re: Get out of Debt! Bad advice?

Plickety, it's great to read a post from someone who sees through the banking brainwash the rest of society believes in.  Banks want all of us thinking it's our personal moral responsibility to pay our debts.  They want us feeling guilty.  They want it associated with our notions of religion and sin.  They promote a selfishly one-sided view that they're just passive people loaning you good money and, damnit, it's your job to pay it back with a lot of interest, and if you don't you're a societal low-life.  What about their responsibility?  What should they feel guilty for?  What is their sin?  

Outside of banking, somebody who promotes that type of system is known as a con artist. 

You have seen the light.  Congratulations.

Contracts are two-way agreements.  It's time that bankers realize this and start treating their customers as customers rather than slaves.  Every other industry needs to get on the phone with partners, customers, suppliers during a downturn to renegotiate pricing and terms.  Banks don't.  They just call the cops on you and take your assets.  It's a government-sanctioned mafia system.  

End the Fed!  and the rest of fractional reserve lending.   

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Re: Get out of Debt! Bad advice?

Great post Erik and great responses everyone.

Here's the general backdrop for my overly broad, probably uselessly so, generalization to get out of debt.

In the Great Depression, debt was a killer.  It wiped out families and took their possessions.

I have been debt free for a number of years and I can tell you one thing; it feels great.   I mean, really great.  In uncertain times, debt enforces a need for cash flow that can be just a real source of stress and worry even for people who can manage it.  So from a social/personal perspective I cannot recommend the feeling of being debt-free enough.  It's fantastic.

When we get down to specifics about mortgages, I have provided advice in podcasts that parallels Erik's, but with a twist.  While I would personally not want to rely on the external randomness of waiting for a government "fix" that would reset my obligations, I do worry that banks will hunt for value in their existing mortgage portfolios, as they did in the 1930s.  What this means is that a mortgage with a high amount of equity is more liable to be foreclosed upon than one with low equity.

Why?  That's simple; it's where the money is. 

So my advice on mortgages is to either have the lowest amount of equity in them that you can, or pay them off. 

But pay one down while stripping your savings account?  No way.  That just doesn't make sense as that merely reduces your options while increasing your risk of bank seizure.

If I were to have a mortgage it would be fixed rate, and maxed out as I watched carefully for signs of inflation or government modification that could be used to my advantage.  And even then, it would be for a dwelling well inside my budget abilities.

But it's consumptive debt that am mainly referring to when I say "get out of debt".  This means debt for credit card purchases, auto loans, and the like.  Further, it means examining purchases for non-essentials (like vacations) that could defer paying down existing consumptive debt and eliminating or severely curtailing them.  

For those with ample funds, debt is a game.  For those relying on an income stream to carry them along, it is another beast altogether.   While this period of time may be unique, I believe it will also mirror the Great Depression and I suspect that a lot of families are going to be ruined by having too much debt.

In general, and as a blanket statement, if I was only allowed one, I would say "get out of debt".

Of course, generalities are always false.  Smile

Best,
Chris

 

 

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SamLinder
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Re: Get out of Debt! Bad advice?
strabes wrote:

Plickety, it's great to read a post from someone who sees through the banking brainwash the rest of society believes in.  Banks want all of us thinking it's our personal moral responsibility to pay our debts.  They want us feeling guilty.  They want it associated with our notions of religion and sin.  They promote a selfishly one-sided view that they're just passive people loaning you good money and, damnit, it's your job to pay it back with a lot of interest, and if you don't you're a societal low-life.  What about their responsibility?  What should they feel guilty for?  What is their sin?  

Outside of banking, somebody who promotes that type of system is known as a con artist. 

You have seen the light.  Congratulations.

Contracts are two-way agreements.  It's time that bankers realize this and start treating their customers as customers rather than slaves.  Every other industry needs to get on the phone with partners, customers, suppliers during a downturn to renegotiate pricing and terms.  Banks don't.  They just call the cops on you and take your assets.  It's a government-sanctioned mafia system.  

End the Fed!  and the rest of fractional reserve lending.   

 

Hi Strabes, Plickety:

I must admit that I'm somewhat dismayed by this attitude of thinking it is ok to walk away from a debt that you took on voluntarily. Perhaps it's a generational thing (I'm 65) or perhaps it's a sign of the times since our banking system has gone awry.

When you bought your house, it was offered at a specified price (let's assume $300,000 just for this discussion). You decided that it was worth the money, so you borrowed some, or all, of the purchase price and paid the seller $300,000. Now, in order to own the home free and clear, you have created an obligation between you and the bank to repay the $300,000 that they loaned to you. As part of the agreement, you agreed to pay a specified amount of interest each month for the privilege of getting the $300,000 up front so that you could buy the house. So far, so good. This is pretty much standard stuff.

Now if, in 5 years, the market value of the house is $500,000 (and you still owe the bank $250,000) and you decide to sell it - good for you, you've made some money without lifting a finger. Pretty much what the bank has done by collecting interest from you for the last 5 years.

However if, in 5 years, the market value of the house is $200,000 (and you still owe the bank $250,000) and you decide to sell it - bad for you. The market value of housing has always fluctuated - no surprise there. So why are you upset because you decided to sell while your house was "upside-down"?

If five years have passed, since you bought the house, and you still intend to live there for years to come, what difference is it to you what the current market value is of the house? You still have a valid contract with the bank (enforceable in a court-of-law) and there is no reason to break it unless your financial circumstances have deteriorated to the point where you can't make the payments that you agreed to five years ago. In that case, there is the legal remedy called bankruptcy.

Plickety wrote:

We're now planning to go back to minimum payments on the mortgage and HELOC and put the extra money into more hard commodities. We are seriously considering (pretty much already decided) walking away from this house... either offering the bank a Short Sale or Deed In Lieu of Foreclosure, or just simply accepting the default foreclosure. The second lender is screwed, they may be able to come after us, but they can't seize our capital assets only our cash/monetary assets... which we won't have because we've cashed them out to purchase useful capital assets.

Plickety - it appears from your comment above that you are financially able to maintain your agreements with both the first and second lenders. Yet because you've decided to homestead somewhere else, you are willing to "stick it" to both contract holders. To say that it's ok because the bankers are crooks anyway is a specious argument. Turn the tables around - how would you like someone else to financially "stick it" to you and your husband because they've decided that it's ok to do so in today's topsy-turvey financial environment?

strabes wrote:

Banks want all of us thinking it's our personal moral responsibility to pay our debts. They want us feeling guilty.  They want it associated with our notions of religion and sin.  They promote a selfishly one-sided view that they're just passive people loaning you good money and, damnit, it's your job to pay it back with a lot of interest, and if you don't you're a societal low-life.  What about their responsibility?  What should they feel guilty for?  What is their sin?

Strabes,

I'm surprised at you making this argument. Using your thinking, everyone should just say to hell with it and default on all interest bearing debt. Damnthematrix would be very happy with this outcome as he's been suggesting it for a long time. Are you going to default on all your debt? Should I default on my debt to the bank even though I have a small mortgage relative to the value of the house and can easily maintain my payments?

What you are suggesting is basically anarchy. Our society will be in for a rough enough ride as it is without everyone defaulting on their debt. We're already seeing a severe lending problem because the banks are afraid to lend because they can't trust that they'll be paid back. If everybody defaults on their debt, the financial system will collapse completely. Then where will you get money when you need it?

The US government won't lend it to you (even at no interest) because they won't be able to count on being paid back. If I had any money, I wouldn't lend it to you or Plickety because you have both stated you are willing to abrogate any responsibility for debt when it suits you.

I hope you both see where I'm going with this. The comments about morality, religion, sin, etc.  are red herrings in this discussion. Trust is the key word. If nobody trusts - well, draw your own conclusions..................................

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SamLinder
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Re: Get out of Debt! Bad advice?
cmartenson wrote:

<snip>

I do worry that banks will hunt for value in their existing mortgage portfolios, as they did in the 1930s.  What this means is that a mortgage with a high amount of equity is more liable to be foreclosed upon than one with low equity.

Why?  That's simple; it's where the money is. 

So my advice on mortgages is to either have the lowest amount of equity in them that you can, or pay them off. 

 

Chris,

Your words take me aback. Perhaps I'm not fully understanding what you are proposing.

I currently have a small mortgage relative to the current market value of my house. That puts me in the position of "a mortgage with a high amount of equity".

I'm having no trouble making my mortgage payment so I am not concerned about foreclosure. Are you suggesting that the concern is for those who are having trouble making their house payment? If so, where are they going to get the money to pay off the loan? If they have money in a savings account, they could use it to make the mortgage payment.

Apparently I'm missing something here - please help me out.

Thanks,

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cmartenson
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Re: Get out of Debt! Bad advice?

Foreclosure is a process.  An expensive process.

For a bank, recognition of the "write-down" value is enforced during the foreclosure process.

Case 1:  Mortgage holder has low equity and is upside down and is having trouble making payments.  If the bank forecloses it will have to recognize a $100k loss.

Case 2:  Mortgage holder has high equity and is having trouble
making payments.  If the bank forecloses it will recognize a
$100k gain.

It's pretty clear which case above will be targeted first by a bank.

A strategy that I was just reading about consisted of private equity and hedge funds buying up mortgage pools with the specific intent to "strip mining" the equity in this fashion.  Certainly it was a common and legal (but unscrupulous) practice back in the 1930's to buy distressed mortgages for pennies on the dollar and then foreclose on them to secure a gain.  

I would be quite surprised if this did not happen again, or is not already happening.

 

 

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Re: Get out of Debt! Bad advice?

Sam, what I'm saying in no way implies anarchy or everybody just walking away from debt. I'm endorsing a 2-way relationship.  It's amazing to see how effectively they have programmed society when just suggesting 2-way relationships in banking is interpreted as anarchy. 

What is so repulsive in saying 1) banks should operate like other businesses and 2) they shouldn't be able to impose such psychological suffering and guilt on people?  Only banks have the power to destroy someone's life or send them to psychiatric hospitals.  No other business, unless you include the mafia, has that power.  And that's promoted by our societal view that not paying a bank on time is deserving of eternal fire and damnation in hell.  This whole charade is a symptom of the debt-based money system we live under.  It's a feudal/slavery system.  Government is in bed with the bankers.  That's why they get to act like mafiosos whereas every other business has to operate like, well, a business that serves something called customers.

Now, I am saying let's all eventually walk away by eliminating the debt-based monetary system.  In the meantime, banks need to get on the phone with customers and see what 2-way agreement they can come to to facilitate a pareto optimal solution which is by definition win-win.  Banks are so bad they prefer lose-lose solutions letting a team of lawyers deal with their customers by hauling them into court and taking their assets just so the lawyers can sell the property to a rich investor for 50 cents on the dollar.  

 

 

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Re: Get out of Debt! Bad advice?

Sam, in Chris' last post you see how banks/investors operate.  You think you're being a good, responsible borrower.  Just wait til they take responsible borrowers' equity. Perhaps your view will change.

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SamLinder
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Re: Get out of Debt! Bad advice?
cmartenson wrote:

Foreclosure is a process.  An expensive process.

For a bank, recognition of the "write-down" value is enforced during the foreclosure process.

Case 1:  Mortgage holder has low equity and is upside down and is having trouble making payments.  If the bank forecloses it will have to recognize a $100k loss.

Case 2:  Mortgage holder has high equity and is having trouble
making payments.  If the bank forecloses it will recognize a
$100k gain.

A strategy that I was just reading about consisted of private equity and hedge funds buying up mortgage pools with the specific intent to "strip mining" the equity in this fashion.  Certainly it was a common and legal (but unscrupulous) practice back in the 1930's to buy distressed mortgages for pennies on the dollar and then foreclose on them to secure a gain.  

I would be quite surprised if this did not happen again, or is not already happening.

 

Chris,

I understand what you are saying, now. Thank you for that clarification.

However, if I have high equity, but having trouble making the payments, wouldn't it make sense to take out a Home Equity Loan (HEL) and pay off the first mortgage? (Presumption is that homeowner has not missed a payment yet but can see the handwriting on the wall.)

As an example:

Current appraised market value of house (bought for $150,000 many years ago) is $300,000. Remaining mortgage is $75,000.00. Owner now struggling to make payment. Goes to bank - takes out HEL of $100,000, pays off $75,000 first mortgage and now has $25,000 remaining. Uses $25,000 to start paying back HEL while waiting for his financial situation to improve (maybe he lost his job and is searching for another one and needs that extra money to tide him over in the meantime).

Am I smoking something here or are my numbers unrealistic? This is something I could do today. My bank has solicited me for an HEL in the recent past. They wouldn't know if I were beginning to struggle to make that first mortgage payment.

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SamLinder
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Re: Get out of Debt! Bad advice?
strabes wrote:

Sam, in Chris' last post you see how banks/investors operate.  You think you're being a good, responsible borrower.  Just wait til they take responsible borrowers' equity. Perhaps your view will change.

Strabes,

We do have a problem seeing  eye-to-eye don't we?  Wink

OK - let's take the bank out of the equation and substitute Joe MoneyLender down the street:

When you bought your house, it was offered at a specified price (let's
assume $300,000 just for this discussion). You decided that it was
worth the money, so you borrowed some, or all, of the purchase price
and paid the seller $300,000. Now, in order to own the home free and
clear, you have created an obligation between you and Joe MoneyLender to repay
the $300,000 that he loaned to you. As part of the agreement, you
agreed to pay a specified amount of interest each month for the
privilege of getting the $300,000 up front so that you could buy the
house. So far, so good. This is pretty much standard stuff.

Now if, in 5 years, the market value of the house is $500,000 (and you
still owe Joe MoneyLender $250,000) and you decide to sell it - good for you,
you've made some money without lifting a finger. Pretty much what Joe MoneyLender has done by collecting interest from you for the last 5 years.

However if, in 5 years, the market value of the house is $200,000 (and
you still owe Joe MoneyLender $250,000) and you decide to sell it - bad for
you. The market value of housing has always fluctuated - no surprise
there. So why are you upset because you decided to sell while your
house was "upside-down"?

To make this even simpler, remove the concept of interest entirely. If you borrow money from someone, or some institution, you are expected to pay it back or lose the collateral that you put up in order to get the cash up front (in this case the house). No one is twisting your arm at this point. Presumably, you are entering into this agreement of your own free will.

I don't disagree with your view of the banking system, Strabes. I think it deserves a complete overhaul. However, in order for society to function beyond a pure barter system, people have to have access to credit. As I said earlier,

If everybody defaults on their debt, the financial system will collapse
completely. Then where will you get money when you need it?

 

strabes wrote:

What is so repulsive in saying 1) banks should operate like other
businesses and 2) they shouldn't be able to impose such psychological
suffering and guilt on people?  Only banks have the power to destroy
someone's life or send them to psychiatric hospitals.  No other
business, unless you include the mafia, has that power.

This comment is not true. Any business or individual that lends money and enters into a 2-way contract with another business or individual has recourse through the legal system in the event of default.

If I, as an individual, loan you money and you default on the debt for whatever reason, I can go after you using collectors and the legal system. Unless you declare bankruptcy, in which case I'm out of luck, I can chase you within the bounds of the legal system until I've destroyed your life or sent you to a psychiatric hospital.

The important thing to remember here - and so many people seem to want to ignore this - is that people borrow money because they want something now instead of waiting for it. Since a house is very difficult for most of us to save for ahead of time, we borrow the money.

At that point we are responsible for that debt - no matter where the money came from! This is the part that I don't understand why it is so hard to accept. It has nothing to do with being a slave to a bank or anyone else. It's a matter of responsibility - a word and a concept that seems to have fallen out of fashion. If you borrow money - pay it back. It's that simple. If you agreed to pay interest, then pay the interest. It's that simple.

Any other argument is unacceptable in my view.

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strabes
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Re: Get out of Debt! Bad advice?

Try going to your bank tomorrow and withdrawing all your cash.  If you have a big account you'll find they aren't as obligated as you are to pay on demand.  1-sided system.  See Byron Dale videos.

Why do we look at the situation in arizona where a woman bought a house in foreclosure and gave it back to the borrower (who she didn't know) who was being kicked out and call that benevolent, wonderful, charitable, community-oriented, loving, yet we have no expectation for banks to operate with the human dimension in mind?  If her act was good, then the bank's act had to be "bad" or at least it was the trigger for a bad situation.  Sure, banks can't operate like a charitable person, but this situation illustrates the immorality of the current system.  The debt-based money, fractional reserve lending world that we live in needs to change.

All I was congratulating Plickety for was freeing herself from the Matrix.  She realizes "hey, the bank took a risk too" and so she's realizing that walking away and/or declaring bankruptcy is a perfectly viable option.  That's not anarchy.  That's healthy perspective.  She's not a sinner if she does that.  She's simply 1 side of a contract where BOTH parties assumed risk.  She doesn't need to carry all the risk burden.  And she certainly doesn't need to view herself as a low-life for treating the bank as rationally and impersonally as banks treat everybody.  It's a cold, impersonal contract.  She's completely free to engage in the legal termination process called bankruptcy or walking away and giving the collateral to the bank.  That's what the bank signed up for.

Having said all this, I'm an ex-corporate guy, so I'm also looking at this from a business perspective and I think what the banks are doing is absurd.  They are carrying assets that are worth 50 cents on the dollar.  Borrowers are carrying liabilities at 100 cents on the dollar.  That type of disconnect is ALWAYS an opportunity for profit.  Let's take the extreme case where banks foreclose on everyone--their balance sheet shrinks to below 50% because investors will buy at below market prices and the banks lose huge processing costs in legal proceedings.  On the other hand, if banks can get on the phone with their customers and, on average, rewrite principal down to 75 cents on the dollar, then everybody wins.  The banks are WAY better off because they avoid lawyers and court costs, they don't have to sell to tough-nosed foreclosure investors who won't pay a penny more than market price, and their balance sheet only shrinks 25%.  That's a better business decision.  Now, bankers say that writedowns don't work because people who were going into foreclosure will still foreclose, but that's in normal situations.  Given this hyper-deflation in which most people will be foreclosing, it is very much in the banks' interests to avoid mass foreclosures and find workable solutions with current borrowers.  

 

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wmarsden
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Re: Get out of Debt! Bad advice?

$100K Home Equity loans aren't being loaned out willy-nilly anymore, particularly to people who have some reason to believe they might have trouble making their regular mortgage payment.

I advise people from time to time to set up a line of credit before they need one, when they've got secure jobs.  I'm not sure how available those lines of credit are these days.  I know some of them have been canceled by lenders or reduced after-the-fact.

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