One of the questions people ask the most is if they should pay down debt or save?
Everyone from financial gurus such as Dave Ramsey to big corporations preaches about the best advice about paying down debt and saving. It seems as though everyone has various opinions. A lot of the information you read online highlights the benefits of all the options and lets you make your own financial decision.
However, Dave Ramsey is a different story. Dave believes in his rules and his steps sternly, and he doesn’t tolerate nuisances or extenuating circumstances. Having listened to his show, I have heard him not only be dismissive of people’s circumstances but arrogantly hang up on guests, like his show is some shock jock radio program. His callers are good people asking for help, and they probably bought his book. They deserve some respect.
One of his “rules” consists of his opinion on the 15-year mortgage. He preaches about how this is the only way anyone should finance their home. Recently, I had the opportunity to debate a 15-year mortgage vs. a 30-year mortgage with my friend Dave from Financial Journeyman. Usually, I try to separate my feelings from the content and show a balance. However, this was a debate; lines needed to be drawn. This was a debate I wanted to win. As they say, “coffee is for closers.”
I immediately set out to research any counterpoint that could be used as a weapon to poke holes in my premises. My research led me back to Dave Ramsey; did he have some biblical or economic rationale to squash 30-year mortgages?
Nope, he simply thinks people are too lazy to have any other type of home financing.
He assumes people are irresponsible with their money and can’t make well thought out financial decisions. He doesn’t preach about the 15-year mortgage because of the benefits. He teaches about it because he believes you are too naïve to entertain any other option. Mostly, you are too dumb to handle your own money so; you must leave it up to your lender to manage your funds.
Here’s Why Dave Ramsey's Tactic Doesn’t Work:
When You Make People Feel Bad, it Doesn’t Inspire Change
This may leave people feeling defeated. By making people feel worthless and unable to manage their own money, they won’t make the necessary changes and make positive financial adjustments. Think about yelling at your child or even your new pet. Do they want to change because you yelled at them? Most likely, they retreat.
They feel discouraged and will continue to make the same mistake because you haven’t appropriately guided them to positive change. If you want people to change and make positive financial decisions, why not try encouragement them? Make them believe they can do it, and some will do it. Don’t kick them when they’re down.
Focusing Solely on Paying Down Debt Could be a Mistake
By selecting a 15-year mortgage, your focus may be solely on paying off debt. You may not have the financial capacity to save or invest. Ever heard the saying, “don’t put all of your eggs in one basket”? By putting all of your income toward your home, you may be doing just that. Just like any other investment, there is associated risk.
You never know if the housing market is going to go up or down. Think about the 2008 housing crash. If you put all of your money into your home, this could have destroyed your financial future. If you have more of a diversified portfolio, you can eliminate some of this risk.
But!!! Dave Says Don't Buy The House if You Can't Afford the 15 Year Payment
Whenever I point out that Dave Ramsey may be wrong on the 15-year vs. 30-year mortgage debate, a Ramsey fanatic will always respond that “clearly I am mistaken.” Dave teaches that you should not buy a home unless you can afford the 15-year mortgage.
However, criticism is flawed. We are not debating how expensive of house someone should buy. The debate is whether someone should finance their purchase with a 15-year or 30-year old mortgage, and there little to debate. The 30-year mortgage provides more flexibility in the case of personal crisis and more opportunities to save money along the way than the 15-year option.
Even for families that are in the position to pay cash for the home, there are several compelling reasons why financing may be preferential Of course if you are in the situation of paying cash for a home is a possibility, likely you have moved past Dave Ramsey's basic advice.
Not Funding Retirement Accounts Could Cost You Tax Dollars and Increase Your Health Insurance Costs
You can contribute to an IRA with pre-tax dollars. Essentially, this means that you don’t have to pay taxes on the money you contribute until you go to withdrawal your funds in retirement. This is also true for a traditional 401(k) accounts. Currently, you can contribute up to $19,000 tax-deferred. By putting all of your money toward your debt, you are missing out on this opportunity to save money on your taxes.
Not only are you cutting your tax bill but also you are setting yourself up for the future. When you invest in the market, you have the opportunity to capitalize on compounding interest. In my opinion, compound interest is pure magic! Now some people may question whether you should take on risk when you have a debt to pay off.
What if the market falls when you are paying down debt, wouldn’t that money have been better allocated to paying down debt? It’s a reasonable question; however, not everything is so black and white; there are safe investments that you can contribute your retirement funds towards such as fixed indexed annuities.
Sure, you won't get all the market gains, but the money is safe, and you can take advantage of tax breaks without betting the farm. Not funding your retirement accounts could also increase your health insurance costs. If you purchase your insurance through the Marketplace, they base your premium on your taxable income. If you are contributing to retirement accounts, you have the potential to lower your taxable income as well as your premium for health care. See: Hacking The ACA
Not Saving Can Lead to More Debt
Does this sound counter-intuitive? Well, it’s not.
By not making saving a priority, you could end up in more debt. Let’s say you only save $100 a month. Your emergency fund is only about $1,000. All of a sudden your radiator goes out in your car which can cost up to $1193. Unfortunately, yours costs just that. With no additional savings, you have to put $193 on credit.
Then a big storm comes and rips off some of your shingles. It turns out you need a new roof. Now what? You are suddenly in debt above your head. So, if you were putting the majority of your money into your home or paying off debt, you would have nothing to take care of emergencies.
What happens if you take a pay cut or lose your job? How will you afford the high payments? At least with some savings, you could boost your income for a while you get on your feet. Keep in mind. If you have so much debt, you may honestly need to talk to a lawyer about bankruptcy. I’m not advocating shirking responsibilities, but sometimes you get dealt a bad hand: disability, health issue, etc.
Waiting Until You Pay Off Debt and Saving More later is NOT the Same as Saving Some now.
Just like in the example above, it may be too late to save. You may need your money now. You can balance paying off debt, savings, and invest. You don’t have to only bet on your home. The other disadvantage of waiting to save until you pay off your home is you are missing out on other investment opportunities.
Missing out on compound interest can be a huge mistake when saving for your retirement. You are also missing out on all of the tax advantages of contributing to retirement accounts. Let’s say you contribute 5K to your 401k. This could save you about 3k in taxes. Essentially, you could have more money to put toward debt or other investments. Balancing debt repayment, saving, and investing, is key to your financial success.
Decreasing your taxes isn’t the only benefit you are missing out on by not saving. You could also miss out on valuable tax credits and deductions. The saver's credit can be worth twice as much. Every year you don’t save you could potentially leave 2k on the table. For example, if you save 5k every year for four years, you will receive four saver credits. If you waited and saved 20k in years five, you would only receive one credit.
Saving a little each year can have a larger payoff than savings a large amount in one year if you are unsure about how to reach out to a tax professional to help you with the logistics and tax strategy.
Why You Shouldn't Listen to Dave Ramsey
Dave is wrong! Don’t allow him to make you feel inadequate to manage your own money. For that matter, don’t let any financial guru or corporation convince you that you can’t make great financial decisions. You have the knowledge and tools to manage your own money. You can balance paying off debt, saving, and invest in your future.