Rule #24 Borrow money for things that appreciate, pay cash on things that depreciate.

"The price of borrowing money is interest—and worry. Keep all borrowing below the worry point and don’t borrow to buy things that depreciate; you will lose on both ends." - Ron Muhlenkamp from his Basic Maxims I Want My Kids to Know.

Cars, vacations, iphones, new bicycles, dinners out at restaurants etc... all lose their intrinsic value the second they are purchased.  Yet people put them on credit cards or take out loans to buy them and carry the balance for months or even years.  So not only is that meal you spent $100 on long gone, but you are now going to pay an additional 10-20% (or possibly more) because you didnt pay it off right away.  Bad idea, Genius.  One of our rules is that we don't buy anything on credit or loan if it depreciates over time.  We view paying more to buy something by spreading the payments over time for something that goes down in value as a silly thing to do.  I know people who buy stuff on credit cards because an item is on sale and then don't pay it off for up to a year or more, essentially negating the sale price.

But the biggest sting is on big ticket items... so let's look at a big ticket example.  One that most people can relate to would be a car purchase. Suppose you bought a car for $25000 and you financed 100% of it for 5 years at an interest rate of 5%. You'd pay about $471 a month in payments.  The car will depreciate 10-15% per year depending on make and model.  For this example, lets assume 15% depreciation.  After 5 years you are still paying the $471 per month, but your car is now only worth a little over $11000.  When you finish paying for it, you will have paid about $28306 once you add in all the interest.  By paying for the car in full at least you would avoid paying the extra $3306 in interest.  A big part of my apprehension is psychological. I recognise this, but I still think its worth thinking about,  You will pay $5600 in the final year in monthly payments, and your car will only be worth the equivalent of 2 years worth of payments...  yeah, that stings.

What if you did without a car for a few years and saved $471 up front each month, how long would it take to save up the 25000 in cash?  Lets also assume you can get a 5% return on your savings. According to this handy online calculator, it would take 48 months to save up 25000 to pay for the car in cash.  You would actually only have to put up $22600 of you own money, and the compounding at 5% per year would do the rest.  You've saved yourself $5700 dollars and you own the car outright.  You can keep saving $471 in your account for your next car that you will pay for in cash.  Since we know you can probably replace your current car for $25000, you will be able to save up the money for your next car in 4 years!  This is generally how we operate.  Save and then buy.  Not borrow, buy and then pay down.

But I'm not against borrowing.... I just dont like to borrow on things that depreciate.   I do however like to borrow money for safer investments or assets that provide some cashflow.

Lets look at borrowing to invest in something that appreciates in value, rather than depreciates.  (NOTE: you should know by now that I don't usually fuss too much over capital appreciation in the short term, but for this example lets assume that capital appreciation is the goal.  We will also not consider taxes for this example even though I know taxes will take some in the end if you sell the investment)   We will borrow at 5% and buy a $25000 investment that appreciates (and therefore compounds) at 5% a year instead of depreciating like the car.  After 5 years, you will have paid the same as the car, $28306, but now the investment is worth $31,907.   So in the case of borrowing to buy a car vs investing, I could borrow to buy a car that will cost me 28k over 5 years and then its only worth about 11k when I pay it off, OR I can borrow and pay the same amount over those 5 years on something that appreciates over time and it would be worth about $3600 more than what I paid for.  So to compare both scenarios with their bottom lines, the depreciating car has lost about $17300 of what you've put into it, and the investment is up $3600.  That's a difference of nearly $21000.  Well, when you put it that way Ryan, that IS a huge difference.

This is the way we've set up a portion of our finances. We only borrow for things that increase in value such as investments, and we save up to buy all things that depreciate.

Rule #4 Never Carry a Credit Card Balance... Ever

"Money is just the poor man's credit card" - Marshall McLuhan.

This one is super easy. Nobody is going to say its a bad idea.... If you do think its a bad idea, you may need your head checked.   Carrying Credit Card Debt to the point where you start paying interest, especially when you have access to cheaper interest rates, is a no-no.  I just did a quick search online and the lowest rate I could find in Canada was about  a 10% annual interest rate.  The majority of the standard credit cards, including the ones we have, charge about 18%.  And if you get a Sears, Canadian Tire, Home Depot credit card, or any other Non Visa or Mastercard, you end up paying 22-28%.  But Ryan, my monthly payment is so low, why should I be fussed about paying it off?  Because its two to five times the interest rate you could be paying if you just got a regular line of credit at 5-7% and moved the balance over.  Or better yet, save your money first and then buy it without having to borrow.  We generally never pay interest on something that depreciates in value (another rule I will write about later) so we almost never carry a balance on any of our credit vehicles.  We view it more as emergency credit.

Okay okay, some people won't save, or want to make purchases before they have the money.  Lets assume you do decide to borrow money to buy something on a credit card and let it ride from month to month. What is the comparison on the amount of interest you pay? Lets say you bought yourself a washer and dryer and it cost $1000, or maybe a hot tub for $5000, or how about a motorcycle for $10000.  Here's what you'd pay in monthly interest for an 18% credit card vs a 6% Line of Credit:

Quite the difference. Remember this is interest... the first 15, 75 or 150 bucks you pay each month on that credit card just goes to servicing the interest...As opposed to the Line of Credit amounts that are one third the credit card rates.  If this isn't a no-brainer I don't know what is.  Use a credit card to buy stuff, and then each month flip the complete balance over to a Line of Credit or better yet pay it off. Easy Peasy.  Don't you feel like a dumb-ass now for buying that motorcycle on credit card and NOT moving the balance over to your LOC?  If you ask me, paying that kind of interest, for consumer items that are worthless within a few years, is the beginning of the death spiral for your finances.

A note about introductory incentives... I once got a card from Sears just so I could get a smokin' discount on some patio furniture. Once I got the bill I paid off the balance and then canceled the card... That card had a 28.8% interest rate.  I kept getting solicitations for opening another card with Sears for years after that... I was in the vortex of their mailing and phone list just for signing up that one time... and I like my privacy... so now I wont even get a card for one of their promos.  They are just looking for a way to rope you into that mega-interest rate.

We use our credits card quite regularly for their convenience - mostly so that we don't have to bring money with us for bigger purchases when out and about, but we always pay them off within a week of making the purchase so that we are in the grace period where no interest is tacked on to the balance... This grace period is something like 21 days but there is nothing stopping the credit card companies from changing that, OR more likely if its not paid off right away I would forget about it and eventually get charged.

In the last 10 years, we have used our credit cards every month, but have not paid 1 red cent in interest on those cards.  We never ever leave a balance on them.  Ever.