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.

THE FLOAT
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.]

CONCLUSION
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.