Saturday, February 15, 2014

Exterminate Debt, Be Free

This is part 3 of 14 of my series on the 14 ways I am changing my financial life in 2014.

Besides not using debt (specifically credit cards but also including any other forms of debt) in 2014 as I detailed when I described my one use for credit cards in 2014, I am also exterminating, or paying off, all forms of debt in my life. At the beginning of 2014, I was guilty of two forms of debt: credit card float and a 401(k) loan.

I stopped living on the credit card float that I described when I wrote: Credit Cards Erode Emergency Funds. It is dangerous and can create a subconscious reliance on credit.

401(k) LOAN
About 1.5 years ago I decided to use my 401(k) account as a bridge loan, spanning a 14 month gap between when I paid for a new house and I received a contractual lump-sum payment. In order to get my monthly payment as low as possible, I reasoned, I took a loan from my 401(k) to put toward my house, reducing the amount of the mortgage, and, hence, the monthly mortgage payment. Then, about a year later I would pay that loan off with funds that I knew I would receive. In the process I would pay myself interest of 4% on the loan I took from myself, or from my 401(k) funds. I wrote about why this was a bad decision here: I'll never borrow from my 401(k) again.

[Author's Note: If you're interested, I used a 15-year fixed mortgage to finance the home purchase. We bought when rates were very low, obtaining a 2.875% interest rate. And, even though that is just about the lowest interest rate imaginable, I am still in a hurry to get the mortgage paid off, but more on that in a future post.]

My background in business finance says that every entity has an optimal balance between debt and equity to finance itself. There are complex formulas to determine what this balance should be. I know, I had and entire MBA course on the subject. No matter how much empirical data and analysis was used as proof, one reality remained: companies without debt survived the economic downturn. Companies with leverage were much more at risk for insolvency, and some ultimately didn't survive. I like my chances with no debt, regardless of what traditional finance principles teach. Debt-free equals freedom. That's what I want and need.