Should you pay down your debt?

The question of whether a person should pay down debts comes up often, when there are forecasts that suggest unemployment rates and consequently debt defaults will rise dramatically in future years. I know some people say, definitely, “Yes”. I would say, “It depends.”

Clearly, at this point, interest rates you can get in a bank are low, and the long term value of most stocks and bonds is very iffy. So from that point of view, if you have assets that aren’t going to earn much in the future, and a smaller amount of debt, you may want to offset the assets against the debt. But not everyone is in that position. And not all debts are not equally important to pay back.

Student loans. Interest rates are generally pretty low, and lenders don’t have much they can take back in the case of default, especially if the reason you cannot pay is because you are unemployed. So I don’t see a point to specially paying them back.

Credit cards and other unsecured debt. The issue with credit card debt is generally the high interest charges that the banks charge you now. Because of this, running up credit card debt is not a good idea, and paying down debt does make sense, regardless of what happens in the future. But if you lose your job and don’t have a way of paying the funds back in the future, there is not much the unsecured lenders can do. So from that point of view, it doesn’t seem like a person has a lot to worry about, if he or she has credit card debt, and should become unable to pay the debt in the future.

Auto loans. With auto loans, if you should lose your job, and not be able to repay the loan, the car might be repossessed. If you are thinking ahead, buying a less expensive car might be an option, so as to reduce the need for a loan, and thus reduce the likelihood of repossession. Defaulting on lease payments would also likely result in repossession. If you want to be sure to continue to have a vehicle, and think layoffs or reduced income (if you sell services, and can sell fewer of them) would be a problem, trading in for a smaller, older, more fuel efficient car might be an option. If you need a truck for your business, and fear reduced business ahead, paying down the truck loan, so as to be sure it is not a problem in the future, might be an option. But if you have a second personal vehicle that you really don’t need and can’t afford (and haven’t paid much on now), I don’t think I would go out of my way to pay down the loan.

Home mortgages. Here, it is not as clear to me what a person should do. If you are close to paying off your loan, and have amounts in your bank account that are earning little interest, it is clearly a wise thing to do. But if you are a long way from paying down your loan, or the loan is for more than the value of the house (or both), I wouldn’t go out of my way to pay down the loan. I don’t see lenders as being to put everyone out on the street. Of course, if you are the first one to default, you may end up out on the street. And this is not what you want either.

One thing you may want to consider in paying down housing debt is where you really want to be located. If you are located in a desert area, where water is likely to be a problem in not very long, you may very well want to move. Now would be a good time to do it–or at least not pay down debt on your existing home. Similarly, if you want to move to be near children, perhaps to be in an in-law suite with one of them.

Debt to pay for new tools, gardening equipment, land for crops, water capture, etc. This may make sense in some cases, especially if you have the time and ability to follow through with your plans. But remember, others will likely not have what you have, and there is likely to be a problem with theft in the future.

Exactly how much debt pay-down or additional debt to do is a difficult question to answer, because we don’t know what our own personal circumstances will be, and we don’t know how conditions around us will be. But we need to make decisions based on the limited information we have to work with now.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
This entry was posted in Financial Implications, Planning for the Future and tagged . Bookmark the permalink.

26 Responses to Should you pay down your debt?

  1. Blunder Dog says:

    While most well read folks these days agree that current debt levels are unsupportable for long, there is much disagreement on what that will mean when the big debt reset really gets going. Those that believe that hyper-inflation is in the cards generally wouldn’t recommend paying down debt as a priority. This assumes that people will be employed in the new high inflation economy, or that one will have other assets to convert as payment (commodities, etc.). Those that believe deflation is the future of economies would say that paying off debt, especially secured debt, is important now. To not do so may result in loss of all assets and perpetual ‘debt slavery’. The bunch at TAE have made a good case for this POV. Either way, IMO, getting out of debt seems like a win/win; the sooner the better. If only it were so easy. Personal debt is one thing, societal/national debt another. Can governments default on their debt while expecting private citizens to honor theirs?This begs many questions:

    When Nations and States begin to default; their social safety nets evaporating, currencies failing, bonds worthless, massive layoffs; will debt even matter. When this happens, IMO, debts and their related claims tend to evaporate as well. Can financial systems and their banks continue to lay claim to unpayable debt on a massive scale?

    Will lendors be able to enforce the terms of these debts?

    Will ‘we the people’ stand for this? Methinks not. When those that created this ‘magic money’ in the first place begin to lay claim to what real wealth exists, what then? Much depends on the speed of the financial meltdown.

    • marty schoffstall says:

      Read “When Money Dies”, written in the 70’s by an Englishman experiening (one assumes) “When the Lights Went Out, Britian in the 70’s” (another great book). WMD was re-released last year, it describes the Wiemar Republic about 1917 through 1928. There were some very interesting things that I didn’t know:

      (1) Most “working men” did all right that were represented by unions, due to the unions essentially holding hostage the government – (think coal). this was
      true until the last 18 months when the Reichmark was replaced.
      (2) The people in the countryside did well, they raised food, they ended up
      owning a lot of expensive “things” like pianos and jewelry that the urbanites traded for cabbages.
      (3) i want to be careful here, but part of the belief system for anti-judaism came out of the negative experience of Jewish speculators in currencies (on the street) and goods.
      (4) speculators did very well, but it was a bit of a hamster run round and round

      You can extrapolate this however you want, but one might consider who holds the government hostage. Some would say the public service unions. But one might look at the Ivory Coast and see who is getting paid there right now.

    • It was Stoneleigh’s recent talk that got me thinking about the topic. To some extent, I think she is right, but not entirely. I can’t believe that people will be thrown out on the street, while a lot of homes sit empty. Like you, I wonder if maybe the debt claims may not evaporate. At the same time, so many other things may change that people will want to move someplace else, so the original property may not be as desirable.

      Stoneliegh’s discussion is based on the premise that the current system will all stay together, but there will be deflation. I am not so certain. If things get that bad, I think there are likely to be major changes that she hasn’t thought about.

      • Eric says:

        A very interesting discussion. I guess my take on Stoneleigh’s talk is that we should expect the unexpected. And given that we don’t know specifically what will happen, our best moves are probably to try and increase resiliency, and reducing debtload is a part of this.

        • Arthur Robey says:

          On the Keiser Report no. 115 I heard that the Banks were walking away from lower value properties. They are cutting their losses.
          However the encumbrances against those properties (rates and taxes) are billed to the person who claims he owns them. (The Banks).
          So let me guess. When this thing unravels, more and more properties will become liabilities and not assets.
          I think that abandoned buildings will belong to whoever pays the rates and taxes. The Municipalities will re-write the rulz.

          Meanwhile, back at the Ranch, these paper assets will remain on the books of some shonky inter-banking deals for the execs to milk this dying cow. Feeding time among vultures is not a pretty sight.

  2. marty schoffstall says:

    I agree with you that “it depends”. The student loan piece I think needs a bit more description because I think there are 4 things that have happened and amplified the negative consequences there: (1) we changed the law to NOT let bankruptcy remove (discharge) this debt, (2) the major expansion of commercial lending for student loans with no regulations on fees, (3) the efficacy of even having a college education, especially a degree in education, liberal arts, etc in the new 21st century economy, (4) the massive expansion of the lending (and even grants) given (3).

    The student loan debt can have some very negative outcomes given those four things, so while I might not “pay it off”, I’d be real careful to consciously set aside fund to
    be able to pay the monthly for some number of years if you can swing it.

    My advice to the various families that I interact with is basically to reduce expectations, endeavor for as much “pay as you go” (somewhat geographically
    limiting, i travel 45 minutes one way to a graduate school half time), and for the
    high school grads, goto Community College and get an Associates degree in something
    practical where you could be employed. (I continue to be amazed at families that will
    pay $45,000 for a year of private college when their child has no idea what he wants to do). After an associates degree maybe you can make a reasoned choice on what to do and where to go, and even put some $’s into your BS.

    • On the student loans, if there is any way of avoiding them (like not going to the school that a person cannot afford), that is clearly the best choice.

      You are right, though, if you do have them there are a lot of nuances, so you have to understand the nuances.

      Also, I think student loans are in some ways like mortgage loans in that it is impossible to command people to do what they cannot do. If young people with these loans can’t get jobs to pay them back, people will rebel, or just default regardless of what the law says. Likely, it will be the lenders who will lose, regardless of whether the law says the debts can’t be discharged in bankruptcy.

      • s-vark says:

        If the government tries to collect from “dead beat” former students, the destitute former students will have to take pay “under the table,” or in-kind. New and improved local grey- and black markets would probably develop spontaneously. We might expect good job growth for IRS and FBI agents and various middlepeople.

        I doubt anyone will rebel. No one seems to be noticing that our government has been slowly decriminalizing fraud the past 15 years (the coup de grace ~ FASB157 ???).

  3. Pops says:

    This is always seems one of the more contentious discussions surrounding peak oil, no-growth economy, transition, etc. Not really that surprising since we in the US save for nothing and borrow for everything, so if you take away our credit you threaten our entire lifestyle.

    Sooo, unless a person is willing to change their lifestyle in a big way, not borrowing is not really much of an option but then I don’t see many people wanting to change much.

    Anyway, years ago I wrote down my 5 Rules for Peak Oil:
    My #1 Rule is Don’t Buy – learn to be frugal and happy with less.
    Rule #2 is Don’t Borrow – banks will not be any nicer in the future.

  4. Jonathan Grobe says:

    I think the key rule is to frugalize your life; to live below your means. As to what to do with the excess of income over expenses there are several options, such as:
    1. Savings
    2. Paying off debt
    3. Preps

    I think savings in cash covering a year’s worth of expenses is much more important than paying off debt. Preps for a short term crisis are a high priority. Long term preps are something you could well end up not using (you lose your job; the best option is to move to a new location–and you can’t take a lot of these long-term preps with you).

  5. Jb says:

    Thanks Gail; this is a topic that worries me. My wife and I have always been frugal. We bought a house 9 years ago that was in our price range and well below the market value. We bought a hybrid vehicle two years ago to replace a 17 year old car when my income was still stable and put down a hefty deposit to keep the monthly low.

    Needless to say, things have changed alot since then. The modest amount of debt we took on is starting to look like a problem. Although we have about a year’s worth of cash on hand, I’m beginning to wonder if we will ever be able to pay it off. It’s upsetting because I feel like we were prudent and played by the rules.

    So my plan is to continue to pay off our debt, try to find more work and do prepping when I can. If gas prices head back up and the work isn’t there, I’m betting I could sell the hybrid. The monthly mortgage is less than the cost to rent, so it’s ‘stay here’ or ‘move in with parents.’ I’m also betting that as long as my wife still has her job, the bank will be willing to negotiate some kind of monthly payment. I will convert my last bit of savings into food/prep items than give it to the bank.

    I agree with you; I can’t image millions of homeless families sleeping outside the homes foreclosed and abandoned by the banks. Squatters will take over and if cities are laying off police officers, who is going to kick them out? I’m guessing there will be broad public tolerance of such practices, at least I hope so.

    I heard a guy today in the checkout line referring to his Federal Reserve Notes as ‘Charmin.’ Funny!

    • DownToTheLastCookie says:

      Kinda makes you wonder what othe public would give up last ? Gasoline, ToiletPaper or their smartphone. And by the way, “Charmin” isn’t cheap.

    • Blunder Dog says:

      “I’m also betting that as long as my wife still has her job, the bank will be willing to negotiate some kind of monthly payment.”

      Beware loan modification programs. Banks seem to be using these programs to take homes that still have equity, even from folks that are current on their payments:

      Arizona Attorney General Terry Goddard [official profile] filed a lawsuit [press release] against Bank of America (BOA) [corporate website] on Friday for misleading customers in mortgage modification and foreclosure practices. Specifically, the complaint [complaint; PDF] alleges that BOA violated a 2009 consent agreement, in which it agreed to develop and implement loan modification programs, by continuing to engage in widespread consumer fraud by misrepresenting to Arizona customers whether they were eligible for modifications of their mortgage loans. “

      http://jurist.org/paperchase/2010/12/arizona-ag-sues-bank-of-america-for-mortgage-fraud.php

      Why would they do this, one may ask? They are skimming the cream off the top to help pay for subprime losses and losses expected to occur after ARMs reset this year, according to some. It’s hard to balance your books foreclosing on underwater properties, so find ways to call in loans that actually have ‘security’. This provides a quicker, albeit smaller return than waiting 20-30 years for someone to pay off their loan, especially when they factor in interest already paid. Perhaps the banks have more distrust of our future than many people here realize.

  6. s-vark says:

    Budget Deficit Accounting Fraud and the Off-Balance-Sheet Student Loan Scam;
    Time to Scrap Entire Student Loan Program

    Inquiring minds have been wondering why the federal debt has been rising far faster than cumulative federal deficits. The short answer is off-balance-sheet scams like student loans and Fannie Mae and Freddie Mac “assets”…

    http://globaleconomicanalysis.blogspot.com/

  7. Jorge says:

    I think that during the next 15 years a lot of companies, of all sizes, will disappear.
    I am paying for a private health insurance.
    I do not know if the insurance company (a big one) will still exist in the year 2026.
    So I do not know if it is worth paying for private health insurance.
    Any suggestions ?

    • I think insurance companies and banks are very vulnerable to financial problems, and many of them will fail, over the next 20 years.

      I think this will especially be a problem where funds are collected several advance for a benefit, for example long term care insurance. I don’t expect the insurance to be there when you need it. I don’t think insurance that guarantees debt (like municipal bonds) will have a chance either. There are just too many defaults.

      There are a few kind that might be OK for a while, like auto and homeowners and term life. With these, the premium you pay relates to claims which will be paid in the next year or two. But don’t think you pay for future claims now.

      • DownToTheLastCookie says:

        You don’t have to look 20 years into the future to see banks and insurance companies failing. The last 3 years must be an all time record.

        All insurance is about future claims. You don’t get to buy insurance for yesterdays auto accident or hospital stay. The purpose of insurance is to transfer the risk you can’t or wish not to manage.

        I sell health insurance for a living. Or maybe I should say “I use to sell health insurance for a living”. Sticking to the theme here. If you have assets to protect then I would advise coverage. If you are young and/or don’t have any assets you could choose not to cover yourself as many do. But don’t think you can get the healthcare you may want if something happens. Yes, if you have chest pains and go to the ER, you are going to get stabilized and then rolled out the front door quicker than an indy 500 race car. Now you are SOL and that bypass surgery you need is not going to happen. If you have a low cost high deductible plan you will get that bypass surgery and live to settle up with the doctors and hospitals over your high out-of-pocket max another day.

        Health insurance coverage is really a month to month purchase, a lot like rent. For individuals the problem is when they become uninsurable or a higher risk after aquiring their coverage and the insurance company pulls out of the market place. My understanding is the “A” company is good at this little trick. A company writes business in a state for a while. Then after a period of time their book of business becomes unhealthy and expense. The company simply pulls out of the market place in that state and dumps their insureds. Only to return another day.

        My best advise, educate yourself and learn to take care of your own health. No one cares about you more than yourself. You will live a healthier and happier life. Don’t buy insurance to cover $100 doctor visits, because the truth is you can’t afford the insurance. It’s great to have this kind of coverage when your employer is paying for it. Find a deductible and out-of-pocket max that works for you and get at least the bare minium.

        As far as long term coverage care insurance goes. It’s more likely the insured failing to make continuing payments before the coverage is needed than the insurance company failing.

        • I am a strong advocate of the better diet and exercise route. I eat a lot of vegetables and fruit and nuts, and some whole grains and fish and olive oil and coffee. I don’t eat much meat or bread or soft drinks or sweets (except chocolate). I walk a fair amount and do the women’s version of weight lifting. My health is far better than average–I don’t even get many colds.

      • marty schoffstall says:

        I think the general problem is anything that is “socialized” will be “gamed” by either the government or individuals. That is the culture that we now live in. Our private insurance is an example of being “gamed” by the Feds. We essentially subsidize the medicaire/medicaid system by being much higher rates through the private system. Sometimes it is the individuals say in the Long Island Railroad retirement system that gamed it through various maneuvers.

        If all socialized systems are going to be subject to gaming of some sort, then we need to ask some hard questions.

        • Blunder Dog says:

          “If all socialized systems are going to be subject to gaming of some sort, then we need to ask some hard questions.”

          Since they (the private and socialized systems) are being run by the same people, one shouldn’t be surprized. Revolving doors and all that. A look at Obama’s new staff members is a blatant case-in-point.

          Gaming the system is how they got where they are. However, they do have your best interests at heart ;-)

  8. Owen says:

    I may throw out some financial specifics later but for now, first impression.

    It is always disquieting to me that in all instances of pursed lip disapproval at living beyond one’s means, the solution is always to consume less and be less extravagant.

    Whatever happened to the other side of the equation? What ever happened to working harder, starting a business on the side, or getting cut throat in seeking promotions?

    Why do you want to consume less? You just kill more people that way. The longer you delay the die off, the more people get born and then get killed. You’d be responsible for that. This is not the right procedure and is not admirable.

    You either embrace oil scarcity’s inevitability or you talk about it only when it is convenient and meshes with your mindset. If it is inevitable, then it is INEVITABLE.
    If it is, then money is an abstract concept and you should run up all the debt you can, because you aren’t going to have to repay it.

  9. Engineer Earl says:

    I want to second Bluder Dog’s comments, above, about banks preferentially foreclosing on properties that have equity. That is exactly what happened to me when my small neighborhood bank got gobbled up by a much larger bank. Fortunately it was investment property, not my primary residence. Per arrangement with the original bank, I was making interest-only payments while the property was for sale. The new bank refused to continue that arrangement, which was their right as the new holder of the mortgage. Where they crossed the line was when they told the court that they had claim on my house without foreclosing on the investment property. I got a lawyer. The new bank turned down all my offers to refinance — which were for the full amount of what was owed. Then they did foreclose on the investment property, but lied about the sale amount, claiming I still owed almost the entire amount of the mortgage. My lawyer at first believed them since no one (so he said) would lie about such a matter. At my insistence he checked and found out that they HAD lied about that and almost everything else. There are more gory details, but this should suffice to make the point. As a side note, the new bank had a friendly buyer for the property.

    So, I am paying off all my debts. I no longer trust banks. There has been a lot of news nationally along these lines. As my experience showed, even good banks can get bought out by a bad one. Credit unions may be an exception, and fortunately I am a member of one.

    • marty schoffstall says:

      That’s a horrible story and I am sorry that you went through it, I fear that it is far from unique. Your lawyer’s disbelief had to hurt a bit too, but it is hard for people to believe that the “powers” would do such things from time to time. Broad injustice probably comes before anarchy, so it is scarey mile marker. Thankfully they didn’t murder you like Naboth for his vineyard in 1st Kings 21.

  10. Russ says:

    What a gloomy bunch trying how to figure out how to get out of their situation without taking any blame or paying their debts.

    Owing money and not planning on paying is the same thing as stealing.

  11. Arthur Robey says:

    Living alone makes getting enough vegetables a problem, without repetitive trips to the greengrocer. So
    Acting on this article I bought a Gairtopf to ferment vegetables. (Sauerkraut)
    No electricity required.
    They will go well with the dried beans which are my staple.
    http://www.energybulletin.net/stories/2011-01-20/sauerkraut.

    I bought a trailer for my bicycle and 2 Yachts, one small 28 ft and one 36 ft voyaging yacht for all sorts of opportunities. (ie coffee trade, 730% markup.)
    My preps are done with pre-earned cash.

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