Mortgages, Student Loans, and Good Debt

Like so many other personal finance nerds, I've spent the last week digging in to JL Collins' new book, The Simple Path to Wealth. I'll spare you another positive review trying to convince you of its merits, or why you should buy it. Not my job, pal.

If you're too cheap to spend eleven bucks on the one book that will finally make you rich and happy, then don't come crying to me in six months when you find yourself destitute, friendless, eating cold pork-n-beans out of a can at the public library, and creeping everyone out.

These are your choices, Bean Can McGee. You just have to live with the consequences.

Despite all the excellent investing advice in the book (which, let's acknowledge, will make you wealthy if you just follow the simple steps Collins lays out) the part that I can't stop thinking about is his bit about the kind of debt Americans are taking on:

Indeed, it is hard to argue that it [debt] has not become "normal." As I write, here in the U.S. Americans carry a total debt burden of 12 Trillion dollars:

• 8 trillion in home mortgages
• 1 trillion in student loans
• 3 trillion in other consumer loans such as credit card and auto loans 

Collins' main point is that you cannot ever truly build wealth if you're still buried in debt. I generally agree with this, but I am someone who believes there are very few kinds of acceptable, and even good debt.

Debt is just a tool, but it's a dangerous one. Like a table saw. Sometimes (rarely) it's the right tool for the job. Often (always) it can ruin your life if you're not careful with it.

Still, those bullet points floored me. The big problem with Americans taking on $12 trillion in debt (in addition to the figure being too large) is that the ratios of consumer, home, and student debt are out of whack. Why is the debt breakdown so lopsided, and in the wrong direction?

Consumer Debt
Let's start with the low hanging fruit. Consumer debt, which covers things like credit cards and debt taken on to buy cars, SUVs, and boats, never has a positive ROI.

Credit card debt has preposterously high interest, and acts as an albatross on all future earnings. No amount of dinners out or vacations should ever be financed at 18%. If you can't manage to pay off your credit card balance at the end of the month, you're not ready to have a credit card.

While vehicles are technically assets, they depreciate rapidly and thus make a positive ROI impossible. Low interest auto loans can potentially provide an arbitrage play and, I suppose, might allow a savvy investor avoid opportunity costs. But the juice simply is not worth the squeeze. The average car buyer does not have $30,000 in cash that he is going to invest immediately after driving home his new Honda. Rather, debt is probably his only option for acquiring that CRV, and the guy is probably buying more car than he would otherwise thanks to the debt.

Given how much of our economy is driven by consumer spending, Americans should avoid this kind of consumer debt like the plague. While some will argue they have to buy a car to get to work in the morning, or have to use credit cards to keep the lights on sometimes, these necessities' real costs are made much, much higher when purchased with debt.

Housing Debt
Homes also have a similarly dubious return on investment. I won't explain why, when there's such a good example already out there, which just happens to be from Jim Collins. Suffice it to say that, as an asset class, properties only keep up with inflation. Throw in the transaction costs, maintenance, repair, and the impact of the ongoing debt service, and renting may actually be a smarter choice for most Americans.

None of this seems to be all that convincing to the American public who, even after the housing crisis of 2008, still have a home ownership rate of 64%.

In the abstract, this may be fine since we all have to live somewhere. You either buy four walls and a roof or rent them. Buying a home can simultaneously be a poor investment (when compared to an index fund) and still be a better alternative to keeping rain off your head than renting.

Still, does that mean housing debt should represent two thirds of our total debt load, while student loans comprise just eight percent?

Student Debt
Student loans are the one and only instance where I applaud people who take on debt, if that's what they need to do to get a bachelor's degree. It's obviously better if your parents invested in a 529, or if you're able to defray some of the cost with scholarships, grants, and summer jobs.

Still, if you must take on debt, this is a risk that typically pays off handsomely if you manage to make it to graduation day. The Bureau of Labor Statistics shows the average earnings of an American with only a high school degree are less than 60% than those of a four year college graduate. The cost of a degree may be rising dramatically, but it still translates to about $1.2 million in additional lifetime earnings (in 2009 dollars) over high school graduates'.

Want to control for conflating factors like gender or race? The income advantage for college graduates persists, even when just comparing white males with a degree to those without.

On top of earning more, college graduates are also less likely to suffer periods of unemployment during recessions. This is an underappreciated benefit of a college degree: periods of unemployment can have disastrous long term opportunity costs.

Borrowing even $100k for that kind of payout and job security is a good bet: a no brainer, in my opinion, when you consider that college is a pretty good time, too.

Even if we ignore the less salient benefits of the college experience (i.e. - ultimate frisbee, hacky sack), taking on debt for a degree is certainly a better bet than borrowing the same $100k for a house, a few cars, a bunch of fancy vacations and restaurants, or an RV. Yet Americans are far more likely to borrow for a house or a vehicle than they are for an investment in their education.

Is it Really the Degree?
But perhaps this all just correlation instead of causation. Might these millions of college graduates just be high achievers? Could they have done just as well if they entered the workforce at 18 with a high school degree?

Perhaps, but that seems like a fairly dubious prediction. I'm of the opinion that a large part of the increased earnings and protection from recessions comes directly from the degree itself, or at least the skills and education it represents. When higher paying, white collar careers require specific degrees just to apply for an entry level position, I suppose it doesn't matter if the degree is the cause or just a correlate. It's a requirement: you're not getting the job without it.

The Best Debt
Going back to Collins' statistics, it's amazing to me that we, as a group, are opting to acquire three times as much consumer debt as student debt. The figures with housing are even more stark: Americans are taking on eight times more housing debt than student debt.

In the same vein, while 64% of all households currently own the home they live in, less than 32% of Americans over the age of 25 have ever earned a bachelor's degree.

I can respect that, in a consumer culture, we have to market things to our citizenry to keep the wheels of capitalism moving. We need people to buy a certain number of cars and refrigerators and food and houses and every type of little luxury that someone else makes their living from. We work for companies, non-profits, and governments that all produce something. If we want to sell the things we produce, then someone's got to buy. So it's no wonder we have marketing agencies blaring the siren of want, that reminds me that I need to keep buying and buying and buying if I'm ever to be cool, sexy, or happy.

But since college grads are able to earn more, and thus can spend and invest more, it would be in our collective benefit if we had a better educated and higher earning populace. Yes, these insufferable, college grad smartasses will annoy us by relaying NPR stories, unsolicited, at every opportunity. They'll throw unbearable themed dinner parties and will occasionally ruin your whole evening by blathering on about their children's "Montesorri Journey." But they will also buy more frappuccinos, massages, and therapy sessions than their high school-only counterparts. It's a tradeoff, and a good one.

But not enough people are getting degrees to make this pretentious future possible. Americans are comfortable taking on debt, but it's all the wrong kind. How do we convince these future, would-be yuppies to go to college while they're still young?

While we'll never be able to stop advertising to convince young adults that their cars and clothes define them, and that they aren't really grown up until they own a piece of land, can't we first create some propaganda about the benefits of college degrees?

Or, at least better propaganda than this?

As always, thanks for reading.