The Switch: From Paying Interest to Earning It

Over the weekend I did a little personal finance housekeeping, sorting and filing statements and other paperwork. My “To-Be-Filed” stack was growing rather large, and I recently had two occasions to hunt for a receipt and warranty card and instead of going right to the folder, I had to dig through the stack of stuff.

While sorting and shredding, I ran across something interesting – an old credit card statement dated June 2009. I scanned the statement, remembering this credit card still carried a balance of a few thousand dollars representing all that was left of my school debt. That is, the tuition and books I billed to my Visa for a couple years after returning to school to complete my undergraduate degree (after giving up several years before that).

This particular credit card had a decent interest rate – 9% fixed, and I thought I was doing well to whittle away the balance over time. In June 2009 that balance cost me $29.58 in interest, or roughly $355 a year.

Doesn’t sound like much? Consider the amount of savings at today’s rates it would require to spin off nearly $30 a month interest. About $20,000 yielding 2% annually.

The Switch

The last statement I received from that card was January 2010, just after making my last payment. Paying off debt is a great feeling, but it takes a few months for “the switch” to really sink in. “The switch” is the cross-over point where you know longer pay interest, but begin to earn it. Of course, you quickly discover that it much more difficult to earn interest than to pay it, but it underscores the saying, “The borrower is slave to the lender.”

Those lenders were making 9% interest off of me. Of course, I allowed it, mostly because I was overly ambitious about finishing school and rather than saving and paying cash, I tried to hurry the process along by running up student debt. Looking back, I do regret that decision, but it helped get me to where I am today.

Had I not graduated from college with debt, and been locked into making payments for those first couple years after school, I may not appreciate being debt free as much as I do now (and I may not have been as strongly opposed to taking on new debt as I am today).

Debt Freedom is Great, but Not Without Anxiety

Back when we were deep in debt, I used to daydream about what life would be like without debt. I envisioned a care-free existence, or at least not a care about anything related money. And for a couple months after paying off our last debt (except the house), we were sort of floating on the financial clouds. It felt great not sending part of my paycheck to banks and credit card issuers. But then a cold realization set in. I was simply back to zero.

For the last couple years of our get out of debt plan we basically stopped everything to making giant payments on debt. This meant we had very little in the way of savings – for retirement, college, emergencies, and even everyday sinking funds for those things that happen every now and then (car tag renewals, vacations, etc.). What used to have anxiety over debt, but now we were feeling anxious because of all the ground we had to make up.

I almost immediately began reading investment books, subscribed to new blogs, new magazines, etc. I tried to soak up as much about saving and investing as possible. I scoured the Internet for the best saving rates, learned all I could about CD rates and bonds and stocks, and moved my tiny savings pile from bank to bank looking for a better deal. I realized I was obsessing over saving in much the same way I obsessed over our debt. Neither form of obsession was healthy.

We eventually settled into a more realistic approach to our money, recognizing that yes, we missed a few years worth of compounding growth to pay down debt. Would we do it over again? Absolutely. Without debt, it should be easier to save and invest going forward. The freedom of living without non-mortgage debt is plenty worth the sacrifices we made. For those buried in debt for such a long time, it turns out just “getting back to zero” is victory enough; everything else is gravy.

Comments

  1. I love this post. My husband and I have been fighting to pay off non-mortgage debt at the expense of expanding our kids’ college funds or our retirements. I have found it really hard to balance our need to save with my desire to pay off the debt (student loans in particular). Given the high interest (compared to savings) our debt is costing us, we look forward to the day when we are back to zero. I hope I enjoy it as much as I enjoy my daydreams about it now. :)

  2. I know what you mean! I feel like I’m still at that starting over level.

    I’m staring at 2 financial paths:
    The First path will make me a slave to savings/investments for the rest of my young adult life (once your a senior, we live off of saving, so that’s why it won’t be my entire adult life).

    The Second path increases my spending via Lifestyle Creep (also called Lifestyle inflation). Following this path means when I’m a senior, I won’t have as much money.

    I’m thinking of trying to creating my own path evenly split between the two (more established) paths. Perhaps I can create a balance between saving and spending so that my family can enjoy life more, while still finishing with a little bit of money for when I retire someday…

  3. We are working through paying off student loan debt in order to get back to ZERO! I think it is well worth concentrating on paying down debt than saving (except for our emergency fund).

  4. I can relate to the, “Now what?” feeling after paying off debt. At the end of this year, with all of our debt gone besides the first mortgage, we’ll have almost $1500 extra per month. Now the question is, how can we make our money best work for us? The answer is a lot less straight forward than I thought. Everyone agrees paying off debt is the best first step but the advice afterward is often conflicting.

    Nevertheless, removing the debt shackles is liberating. The problem of how to best utilize all our extra money is one I look forward to having.

    • @momcents – Why not pay down the first mortgage with the extra savings you have? (assuming you’ve already built an emergency fund). I got a mortgage during the bubble years (5.75% interest). The way I look at it, paying it down makes me 5.75% guaranteed interest for atleast a few years. That is way better than the paltry 1-2% on any CD.

  5. To me, debt reduction was always the easiest activity. You set up a budget, you squeeze out a few extra bucks and send what’s leftover to your debt of choice.

    Investing+Saving is so much harder. You literally have an infinite amount of choices with regards to risk vs return. That is why I’ve opted to pay down mortgage debt instead of invest (aside from 401K which we still do). It’s just easier. Being 100% debt free will require much more time and effort to manage your money, not less, IMHO.

  6. Congrats on being debt free. Hope your plans on interest savings in the future always remind you of how successful you have been in getting out of debt.

  7. This very topic is infuriating my wife (well infuriating might be a tad strong). We have a large chunk ofr money saved as cash for our emergency fund as well as other earmarked savings categories (vacations, house upkeep, kid stuff) and we’re getting nothing for it. When we were saving for the down payment on our house we would regularly get a hundred or two hundred in interest payments every month. Now, with our balance back to where it was we’re lucky to get $30.

    My wife feels like we’re missing on the critical early years of compound interest. You know, the whole story about how time is more important than the amount of your contributions. I’m nervous to get any more aggressive with this money than an ING type savings account as I don’t want to lose principal. We are, however, beginning to think about opening up a taxable account to invest a little money every month into an ETF or some other low cost investment vehicle to attempt to improve our rate of return.

    It’s frustrating to be on the right side of this equation but get nothing for it.

    @Robin – be careful how aggressive you are in paying down debts that carry nominal interest rates (my student loans are at 1.65% – also deductible) as if you are too aggressive you can severely limit your cash flow flexibility. Especially in this type of economy where jobs can be lost without much warming, free cash is vital.

    @momcents & @ken – this is a complicated equation. Since the mortgage interest is deductible it isn’t costing a true 5.75% to have this loan. Second, future dollars are cheaper to pay off a debt due to inflation (ie a dollar today is worth more than a dollar tomorrow). Average inflation rate is around 2% so take that off the rate as well. It’s only costing momcents 3.75% in today’s dollars to borrow this money (at worst, not factoring in the interest tax deductions). It’s difficult to find safe savings vehicles right now to get 3.75% but by finding some safer funds to save with she has the potential to out earn her mortgage rate plus have flexibility in the future if cash is needed.

  8. Zero sounds good to me! Once there I think you can use that monthly income to make up ground on saving that you lost. The key is being as diligent saving money as your were when paying off your debt.

  9. Great post! I am currently struggling with decision myself. I am trying to decide between maxing out my Roth IRA (what I’m currently doing) or doing super accelerated payments (already paying a couple hundred extra) on my car loan (5%) then student loans (5.75%) after that . It’s tough because I feel like in this down market there is no better time to invest but at the same time, I want to get rid of that debt. It seems like every day I swap sides on my decision.

  10. @ Thomas B.
    Sounds like you are doing the right thing to me. If you are young and maxing out your Roth IRA and still able to pay extra on your loans (which look to be at pretty reasonable rates) you will come out ahead. You have prime compounding interest years ahead of you. Keep it up and as your income grows throw that money towards the debt while still maxing out your Roth IRA (and 401k if you have one so you get the company match). Good luck.

    • Stu,

      Thanks for the advice. Yeah I forgot to mention my age. I’m only 24 :-) . Right now my car loan payment is $355/month and after I found out my company doesn’t match my 401k contributions, I stopped contributing to that and bumped my car payment to $650/month. Right now, I’m just paying the minimum on the student loans.

  11. Especially if most of your debt was at a greater than 1% interest rate, I don’t think it’s so much that you missed an opportunity for compound interest by *paying down* debt, so much as that *being in* debt caused the missed opportunity. Otherwise, if you were in debt and saved as opposed to paying it off, you’d still be losing money overall.

  12. Great Post!

    I find myself in this same position – in 2009, we were $30,000 in the hole with credit card debt. We paid that off in less than a year! Now the only debt we have is our mortgage, and I intend to pay that off as quickly as possible.

    But part of me struggles with – should we be going back to try and max out my husband’s retirement plan ( i have a government defined pension plan through work). We have $10K in emerg fund, RESP for the kids which could use a litte more monthly contribution, Christmas Fund and Vacation Fund.

    Sometimes I don’t know where to put the extra money, although my current plan is to take the extra money that I was spending on daycare (now that my kids are going to school ful time) and throw that down on the mortgage. If I could be 100% debt free including mortgage I would imagine feeling like I have a lot more money in my monthly budget to play around with!

  13. Striking a financial balance in our lives has been a significant post-zero challenge for my family. Financial independence is a laudable goal but at what cost? The ability to truly expand our life experiences, whether through travel, incremental education, etc., is compelling. Creating life experiences for our children is equally or more compelling. Further, we feel morally and emotionally compelled to pay it forward through contributions to church and charity. However, all of these come with a price tag.

    The simple answer is “everyone must find their own balance.” However, that’s a tough transition for many, including me, after the obvious goals of paying off debt and adjusting lifestyles to live within / below our means. The “rules” and “guidelines” that people espouse for other elements of life don’t necessarily apply once a person has regained spending power. For example, buy a house less than 3x your income and pay off revolving debt.

    I appreciate FD’s and other’s perspective in the article and comments and would appreciate hearing about the post-zero goals and ambitions of others. Perhaps the answers are obvious for some (eg, just travel for travel’s sake), but for me they’ve certainly been less so. Thanks.

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