When I wrote recently about the joys of the 15-year mortgage, I got the same reaction from a lot of people: “Why would you repay a loan when at these low rates, it’s practically free money?”
I hear this about a lot of things. “Why would you buy a car for cash/save up to remodel the kitchen/have an emergency fund instead of a home-equity line of credit? Mathematically, that’s insane!”
I don’t think it’s quite as arithmetically unreasonable as my interlocutors suggest. Once you add risk into the equation, the calculations don’t come out quite so neatly. By refinancing to a 15-year mortgage with a lower rate, we locked in 125 basis points a year, completely risk-free. And when the mortgage is completely paid off, we’ll get another 3.25 percent, 100 percent guaranteed and risk-free. There are no risk-free investments that deliver that kind of return. You can make more money by adding risk – but you can lose more that way, too.
Moreover, math is not the only consideration. As I’ve noted before, personal finance is not primarily about math; the arithmetic part is so easy that even journalists can do it. The hard part is discipline.
From time to time, I write about Dave Ramsey, the personal-finance guru who advises people to get themselves entirely out of debt. A lot of people think that the power of his program is getting rid of all those interest payments. And if you have a huge mountain of 18 percent credit card debt or you’re cycling thousands of dollars’ worth of payday loans, then yeah, the interest rate is your big problem.
But for most people, that’s not the case. For most people who are really struggling with debt, the principal is their problem, not the interest: the $30,000 truck on a $35,000 income, the six-figure student loans, the house in the “stretch” neighborhood that’s eating up 40 to 50 percent of every paycheck. Going debt-free fixes their problem not by saving them all those interest payments, but by making it harder to buy things they can’t afford.
Every purchase is a trade-off; you buy this, thereby giving up the opportunity to buy that instead. Debt makes those trade-offs less painful because people care more about now than later. So you get to have this right now while leaving most of the foregone consumption for later periods. Effectively, you lower the current emotional price of consuming something expensive.