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For decades, debt has been a way of life for Americans. Gone are the days when a mortgage was the only sizable debt someone would take on in their life. Today, it’s not uncommon to see a car payment the size of a house payment from the ’90s.
In 2015, Standard & Poor conducted a financial literacy survey and found that Americans are getting financially dumber. Financial literacy has been decreasing for decades, which could help explain why debt has been increasing.1
Americans now hold over $1 trillion in credit card debt, and over $13 trillion in total debt. The credit debt includes those who pay it off each month, but more than 6 in 10 adults carry a balance from month to month.2 Around half of the $1 trillion in credit card debt is revolving debt. Auto loans are over $1 trillion as well, according to Nerd Wallet.3
The good news is that our kids don’t have to fall into the debt trap.
Not Getting In Beats Getting Out
Let’s be real, most Americans are broke. 70% of Americans are in debt, and 50% think they always will be. 78% are living paycheck to paycheck. And most don’t have enough savings to cover even the smallest emergencies.4
If you read an article on becoming debt free, the first step is always the same: don’t get into any more debt. If your child hasn’t left home yet, he’s likely not in debt yet, so he can skip this step. That puts him one step ahead of most Americans. That one step could mean the world.
It’s easy to not get into debt. It’s much harder to dig your way out.
It’s possible for your child to never pay interest a day in her life. It’s easy, actually. All she has to do is refuse debt. Trust me, it’s possible and sustainable to live a debt-free life.
Refusing debt starts by refusing credit cards.
The Psychology of Spending
I’ve been through many stages of thought on the “cash vs. credit” debate. I started by loving credit cards, and never paying them off at the end of the month. Then I read Dave Ramsey’s books, and cut up all of my credit cards.
After I crawled out of debt, I started getting into credit card rewards, and I went back to spending almost 100% on credit, but paying it off each month to avoid paying any interest.
Now I’m back to preferring cash over credit, and here’s why…
Studies began a few decades ago to look into the spending habits of people who use credit cards, compared with cash spenders. In 2001, MIT did a study involving college students bidding on three different items. When the students were allowed to use credit cards, they spent between 80%-100% more than students using only cash.5
A decade later, a study in the Journal of Consumer Research gave some insight into why people spend more with credit than cash. It turns out, people tend to associate credit cards with the benefits of the product they’re buying, yet they associate paying cash with the cost of the product.6
This isn’t by accident. It’s mostly by marketing. We have the major credit card companies to thank for that, but “benefits vs. cost” isn’t the only reason we spend more with credit. Hal E. Hershfield Ph.D. explains that when we purchase on credit, we have more time to think about the purchase, between the time of the transaction and the time we actually pay the bill.7
Studies continue to confirm that we spend more with credit cards. From restaurant tips to auto tolls, we simply spend more in every area, when we use a credit card, according to a study from ValuePenguin.8
Credit Card Rewards Vs. Overspending
I’m all for credit card rewards, but given the studies above, I’m not so sure they’re worth it. I still use credit cards, and get rewards from all of them, but I’m actually considering making a change.
Cal Newport, author of Deep Work, talks about the “any benefit” of things in his book, meaning that we tend to stick with things as long as they provide any benefit. It’s important to look at what provides the most benefit. I think it’s plain to see that, while credit cards do offer benefits, cash offers the greatest benefit by spending less money overall (even factoring in rewards).
I am highly intentional with my spending. I stick strictly to a budget. Yet, I still believe I would spend less if I used cash. Cash is real. We see it leaving our pockets. Credit seems more like pretend. We’re chasing credit card rewards, while spending way more than we otherwise would, and all too often digging our way into a hole (i.e. debt).
Even with an overly conservative estimate—taking all above studies into account—we spend around 10% more when we use credit than when we use cash. Is that worth the 1%-5% cash back? I don’t think so. Especially since 20% or higher is more likely how much we’re overspending with credit.
Perhaps we should encourage our kids to never get caught up in chasing credit card rewards, and to stick with cash. That never opens the possibility of falling into heaps of credit card debt. Why encourage credit for the any-benefit, when we could encourage cash for the most benefit? And also take away the possibility of our children drowning in debt.
The Great Car Payment Myth
Oh, car payments. Everyone has one, right? Well, actually, it seems like it’s more of a poor and lower-middle-class thing — not because they have less money, but because they buy more car.
Car payments are getting higher, and car payment terms are getting longer — up to an average of 66 months. On top of that, Americans are borrowing almost $1,000 more overall on the average loan.9
In The Millionaire Next Door, Thomas J. Stanley, Ph.D., explains how the average millionaire doesn’t have a car payment, and he doesn’t have a new car. It’s typical for the average millionaire to drive a slightly used car, and pay cash for it. But this isn’t just for millionaires.
The only car payment your child should ever have is a payment to herself, in an interest-bearing account. Once she buys her first car, she can start saving for her next car.
Even if she puts it into a savings account that bears practically no interest, she’ll still have $24,000 after five years of saving $400/month. That means zero interest paid, and zero debt. If you instill this mindset before your child leaves home, she’ll never have a car payment in her life.
How to Get a Debt-Free Degree
What about college? Student loans are necessary if you want a good education, right? Nope. Student loans aren’t a necessity. It’s actually fairly easy to go to school without going into debt.
How do you get the degree without the debt? Here’s how:
- Save for college. You can use a 529 plan or other college savings option to save for your kid’s education. Whether you plan to help or not, they can still save. Their teenage years are an ideal time to work up some savings for school. If they know they’re going to college, why wait until they graduate high school to consider the cost?
- Choose an affordable college. There’s no reason to cross state lines for school, and your local community college may be all you need. At a minimum, once you confirm that the credits transfer to your child’s college of choice, get the core classes knocked out at a community college. Contrary to popular belief, few employers actually care about where your degree comes from; they just care that you have a degree.10
- Apply for scholarships. If your child chooses not to work, or not to save for college, they can at least apply for scholarships. This can be a full-time job. It’s best to set a goal, like two a day. If your child applies for two scholarships a day, for their entire senior year of high school (even just 3-5 days a week), they’ll not only get better at writing papers, but they’ll see a nice return on investment (investing time, receiving money).
- Work through college. Finally, if your child doesn’t have savings for school, and they don’t have enough scholarships to cover the cost, it won’t hurt them to work their way through college. The benefit to working through college is actually threefold: 1) working while in college tends to keep kids away from an unproductive party life, 2) students who work through school tend to put more energy into their studies, and 3) students who work part-time (not full-time) have better grades, according to multiple studies.11
- Join the military. Obviously this option isn’t for everyone, but between Military Tuition Assistance, and the GI Bill, you can have an entire degree paid for by the US military. You’d be surprised how many people join purely for the education benefits.
It turns out that “everyone has student loans” is another myth. And just because most people may have them, that doesn’t mean your child has to. It’s actually easy to get a debt-free degree. Much easier than a lifetime of student loan payments.
How to Never Have a Mortgage
Mortgages are like car payments, but it’s much more understanding that you would need a loan for something that costs six figures. That still doesn’t mean anyone needs a mortgage. It’s highly possible to buy a house without one.
It seems like, as part of the American Dream, we’re encouraged to buy a house when we first start our life. We supposedly need our own home. We hear things like “renting is throwing money away” and “you need to buy your own home for your family’s sake.”
Both statements are false. Renting is a necessary part of progressing through adulthood, and at no point do you ever need to buy a home. I’m not saying you, or your children, shouldn’t buy a home. At some point, it’s nice to have a home that belongs to you, that you can do whatever you want with, and that you don’t owe someone else money for. But that doesn’t have to take 30 years.
If you have to finance something, that means you can’t afford it. Take that mentality into home ownership, and it doesn’t seem like anyone can afford much. Here’s the secret: you can’t. Not when you’re first starting out. That’s why it’s called a “starter home.” It shouldn’t be much of a home. Not yet.
The Trade-Up Approach to Home Buying
If your child starts saving for his first home as soon as he moves out, he can have enough to buy a small starter home in about 10 years. That means renting, as inexpensively as possible, for 10 years, to pay 100% cash and 0% interest for his first home.
Mortgages cost more than we think. They often end up costing people 2-3x the price of the home, over the mortgage term. It’s perfectly fine for your kids to start with a small home that they can actually afford.
If your child refuses to go debt-free with their first home, encourage a maximum of 15 years on their mortgage. Look at the difference:
A standard $150,000 home, on a 30-year, fixed 3.9% interest rate (current standard rate), comes out to $104,700 in interest paid over the life of the loan. The same loan with a 15-year, fixed 3.6% interest rate (current standard rate – shorter loans have lower interest rates) comes out to $44,346 paid over the life of the loan.
That’s $60,354 less in interest, and you’re not even making double-sized payments. The payment for that 30-year loan would be around $1,050, while the payment for a 15-year loan is $1,425. That’s less than a $400/month difference to save over $60,000 and 15 years.
If there must be a loan, make it short. But there doesn’t have to be a loan. Once your child buys her first starter home, makes some improvements, and sells for profit, she can buy a nicer home. Assuming she continued saving for her second home.
As long as she gets a good deal (remember that money is made on the buy in real estate, not the sell), she can keep trading up until she gets that dream home.
Do You Really Need a Credit Score?
All of this debt-free talk always leads to the “but what about my kid’s credit score?” question. And the answer is: they don’t need one.
My credit score is high, but I never use it. It’s kind of a waste really. If I would’ve known that I didn’t need one, I wouldn’t have tried so hard to make it so high. A credit score is really just a debt score. You can see that by seeing how your FICO score is made up:
If your child never gets into debt, they will never need a credit score. Period.
In preparation for this article, I did some Googling to find out why people think you need a credit score. US News gave five reasons, and none of them are valid reasons to live a debt-full life, just to get a credit score. Here they are:
- Renting an apartment
- Buying a home
- Refinancing student loans
- Getting a credit card
- Getting your next job
The Balance gave five reasons as well (as a side note, I do appreciate that The Balance also wrote an article on living without debt and without a FICO score). Their reasons were similar, but they added: having a low car payment, funding a small business, and utilities. Basically, those are eight different things that supposedly warrant a credit score. Let’s address each one of these:
- You don’t need credit to rent an apartment or get your next job, you simply need references. Moreover, if you explain your debt-free lifestyle, that will typically intrigue the apartment manager or employer, and often set you apart from the competition.
- If you don’t use debt to finance your home, your degree, your business, or your car, you won’t need a credit score. You’ll just need actual money.
- The only thing that may change when it comes to your utilities, if you don’t have a credit score, is that you’ll have to pay a deposit, which you will get back, because it’s a deposit.
- I’m not going to address the credit card point. I think you get the idea.
If you can find one small thing that does require a credit score, I promise you it’s not worth it. Even if your child does decide to take out a mortgage, he can use manual underwriting to prove his ability to pay back the money.
While having low credit can affect your children in things like job searching, utility payments, and business ownership, having no credit doesn’t affect them in the same way.
Having no credit often sparks curiosity in employers, and I’ve actually heard of people being called back in for a second interview because the employer was so curious about the applicant having no credit (and no debt). In the case I’m referring to, the person actually got the job partially because of the conversation on being debt free. His boss felt that it showed a sense of responsibility. Because it does.
Debt Free for Life
Your kids can win the debt fight: 5 to 0. Those are the five main areas that debt creeps into people’s lives: credit cards, auto loans, mortgages, student loans, and the “need” for a credit score.
I’m not going to mention things like payday loans, or any other short-term personal loans. I don’t think I have to. Even debt-lovers and credit-score chasers alike tend to know how stupid those types of loans are.
It would’ve been nice to know about all of this before I got my first credit card. I grew up thinking debt was just part of life, like most people think.
This is a pretty radical way to live, and a lot of people scoff at it.
It’s hard to shift a paradigm that’s so deeply woven into our culture. You can, however, raise your child to live a debt-free life. They never have to go into debt. They can truly live a free life that most people will never get to experience.
As I always say, if we can teach our children financial literacy now, we won’t be showing them how to dig their way out of debt later.
Further Book Reading
- Debt Free for Life by David Bach
- The Total Money Makeover by Dave Ramsey
- The 4 Principles of a Debt-Free Life by John Schneider, III
Further Bible Reading
Last Updated: June 26, 2020
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- U.S. Department of Education. (1994). Undergraduates Who Work While Enrolled in Postsecondary Education: 1989-90. National Center for Education Statistics. | Dundes & Marx. (2006). Balancing work and academics in college: Why do students working 10 to 19 hours per week excel? Journal of College Student Retention: Research, Theory and Practice. 8. 107-120. | Pike, Kuh & Massa-McKinley. (2009). First-Year Students’ Employment, Engagement, and Academic Achievement: Untangling the Relationship between Work and Grades. NASPA Journal. Volume 45, Issue 4, pp 560-582.