Rule #2: Stay Out of Debt!

Today I spent quite a lot of time reflecting on building wealth, and somehow I remembered one of the experiences I had a few years ago. I was a young doctor at the University Hospital in Frankfurt. Our old Mitsubishi Lancer was turning 8 years old and had reached 200,000 km. It had started demanding money and repairs, so we decided to replace it. Its place was taken by a BMW 5 Series with all-wheel drive, which at the time cost €35,000. Naturally, I didn't have the money to buy it, so I took out a car loan. After paying off this loan for two years, we decided to buy a second car, a Mercedes A-Class for my wife. The bank's idea of refinancing the entire loan into a new one to avoid paying double insurance on both loans seemed brilliant to me. A real helping hand from the bank. Can you imagine what I would have done if someone hadn't thought about my well-being?

However, by rolling the remaining balance of the loan into a new loan, what happened was that during the first years I had predominantly paid interest and very little of the principal, and by rolling it over, I exposed the remaining balance to new interest charges. So basically, the bank suggested that I pay interest on the loan all over again, and I was very happy to accept. Just 24 hours after buying the car, I came home to my wife and confessed that I didn't like it. It seemed too wide, too big, the engine had too much horsepower, and I found it somewhat intimidating. I felt like it was driving me rather than the other way around. It didn't suit my personality at all. Why had I bought it? Where the hell had Rule #1 gone when I made this purchase? Did it change my life? No! I had broken not only Rule #1 by buying a car I didn't need, but also Rule #2 by going into debt for it. Not only that, but years later I refinanced the entire debt, like a student of stupidity and idiocy, breaking Rule #2 for a second time. I only realised how badly I'd been ripped off after seeing a loan repayment schedule in the final year. That was when I realised that only then was I actually paying off the original debt. All those years, I had been paying nothing but interest to the banks.

For this reason, to me, debt is an unacceptable burden that turns us from free people into slaves. Not only do we become slaves, but we remain slaves. These days, we're discussing more and more often whether we want to buy a property of our own and stop renting. What would the debt we'd have to take on look like? And how could I explain to my wife that, in fact, I no longer want any debt at all?

Nowadays, getting into debt is very easy. Whether it's a car loan, a mortgage, or even ordinary purchases such as refrigerators and other household appliances. Everything is sold in instalments at increasingly high interest rates. The problem we fail to notice is that the lending mechanism exists solely to make money for banks. We take out a loan because, more often than not, we don't have the necessary money. If we don't have enough money to afford a car, why do we think we can afford that same car when we're paying an additional 10–15% in interest per year? The interest we pay, whether it's 5% or 10%, is not for the entire duration of the loan. So I don't buy a €20,000 car and pay 10% interest, giving the bank back €22,000. The 10% interest is annual, so if the loan is over 7 years, most often I'll pay approximately €2,000 in interest per year, and my €20,000 car will easily end up costing more than €30,000. How the hell can I not afford the car in the first place, but somehow afford to pay almost double for it? That's the problem most of us fail to notice.

If we look at our friends and acquaintances, they all have some form of loan or debt. For this reason, living with debt is socially accepted. Isn't this what people who have the ability to generate money do to build wealth? In reality, we're not generating wealth for anyone except the sector into which we're introducing this debt. If we all buy cars on credit, manufacturers will raise their prices. Car loans and leasing are the main reasons why car prices have increased so much. Essentially, they make cars affordable so that people will buy them. Most car manufacturers nowadays also offer us the loan, meaning they manage to sell us something overpriced and then charge us interest on the money they've lent us. Their margins can therefore, in certain situations, reach three times what they would otherwise be.

Extending this reasoning to other goods and services, most businesses would probably have to reprice their products and services if the lending mechanism didn't exist. Goods that don't sell because people can't afford them will drive the market down. Our battle with ourselves begins the moment we accept that debt is not something normal, nor is it something desirable. Debt is simply what destroys our ability to become wealthy. Given enough time, our lifestyle will collapse under the burden of the interest payments that have to be repaid.

Read carefully everything I've said so far and think about why you would ever want to be in debt. Debt is something we should want to run away from like the plague. If there are situations in which it cannot be avoided, such as buying a home or a car, we should try to reduce it as much as possible. This is where we need to remember Rule #1: When does enough become enough? And if we went beyond that level, how much would our lives actually change?

I, for example, am currently analysing the housing market in search of a home. Here I have two possible options. I can buy the cheapest home that still meets my needs, or I can buy the most expensive home I can afford, getting myself into debt up to my neck and hoping that once I've moved in, my life will change substantially. Most likely, it won't. Right now, spending more money on the quality of the food I eat seems far more important to me than spending it on some cold, empty walls. My children won't grow up healthy just because they grow up in a bigger garden, but they will grow up healthy if they don't eat spoiled food.

Any of you can embrace this approach: when you want to buy a car, think about what you actually need from it rather than what brand will impress your neighbour. Most likely, you'll save a substantial amount of capital, capital that can be used to get out of debt as quickly as possible or invested in stocks.

But what do we do with our debts once we've accumulated them? We look at them as losses. As lessons we needed to learn or mistakes made by our younger selves. And we don't stop until we've paid them off as quickly as possible. Once we've got rid of our debts, we need to run away from them like the devil.

Only a debt-free person is a truly free person.