The Deal with Debt

How do you deal with debt?

Saving is essential, but what if you have loans to pay up?

A few years ago, I was religiously putting money away in savings while also paying off student debt and a car loan. Then I realized that this is like pulling money out of one pocket and putting it in the other. It serves no purpose.

I often see this. People work hard, keep a careful budget, and put away money but view that money as "savings" and feel it shouldn't be touched. At the same time, they make monthly payments on their debt, plus interest.

This type of behavior can also give someone an overly optimistic view of their finances. They'll say, "Wow, I have $50,000 saved up." But if they have a car that's financed for $20,000 and $20,000 in student debt, they really only have $10,000 in savings.

Obviously, don't touch the emergency fund, the three months' worth of living expenses you have put away-if you don't have that, you'll end up in even greater debt if a real emergency comes up. But the rest of your savings is better served paying off your debt.

Why it’s Worth It

Everyone I speak to about this concept inevitably gives the same reason for not paying off their debt: "I can earn more investing my money with around 10 percent returns than simply paying off my debt."

This may be true mathematically, but there are several other factors to keep in mind.

First, you need to actually have the money invested. Back when I worked this way, my money sat in the bank under the assumption that I would one day invest it. Often, people plan on investing the money but don't get around to it-they'll do it when they have time-so they aren't actually earning more money this way.

Next, you need to know the numbers and see if they really add up.

For example, student loans in 2024 generally come with 6.5 percent interest. Contrast that with a high- yield savings account that offers less than 5.5 percent APY. That type of tradeoff isn't worth it.

It may make sense to invest in a low-cost index fund like the S&P 500, which has averaged around 10 percent in the long term. However, this entails more risk and, as is generally the case with stocks, is only worth it if the money is put in for the long term. If you plan on removing the money in two years to buy a house, then the 10 percent returns aren't guaranteed, and you may lose money on that investment.

Car loans are another common source of debt. Average auto loan interest rates in 2024 are 7.18% for new cars and 11.93% for old cars. The lowest rate for a brand-new car with excellent credit scores is currently around 5.6%. Here, again, unless you're buying a brand-new car with a very low rate and the money you're putting away won't be used for at least three to five years, it isn't worth it to go that route.

But the worst type of debt is credit card debt. The average rewards card's APR is 20 percent, and the lowest possible (for cards designed to have low APR) is 14%. If you have 0% APR because it's a new card, then it may make sense, but keep in mind that as soon as the 0% APR offer ends, you'll immediately need to come up with the money. It's also easy to lose track or overspend, and many people end up slapped with a huge bill because they didn't realize when their 0% APR ends.

Eating Bread Three Times a Day

Finally, choosing what to do with debt is not purely a financial decision.

Morgan Housel, author of The Psychology of Money, explains that every dollar of debt is a piece of your future the lender owns. Every dollar you own is a piece of your future that you own.

If you have one week's worth of savings in the bank, then technically you have one week that you don't need to work, one week that belongs to you. On the other hand, if you owe someone else a week's worth of wages, you don't have the luxury of taking off. You need to keep working until you pay them back, and the earnings don't even belong to you; they go straight to the lender. Any future purchases or choices are in a sense dictated by your debt.

So even though it may sometimes make more sense financially to pay off a low-interest debt in installments while keeping money in savings, this type of decision shouldn't be made with only finances in mind. Eating plain bread three times a day is also a great financial decision-think of all the money you'd save!-but since there are other factors, we don't let our finances decide. The menuchas hanefesh people get from not having debt can be worth it. Of course, this has to be balanced responsibly. If someone has low interest on a mortgage, for example, it can make more sense to pay it off in installments over the lifetime of the loan.

On the other hand, some people find debt very scary and are a lot more motivated to come up with the money to pay off their debt than to find money to invest. This can sometimes be a hurdle. There are times when debt is a good thing, but in this case, make it work for you. If the debt will motivate you to work harder than you would to invest, then focus on paying that off first.

Even if the debt you owe is to a family member or gemach with no interest attached, it may still be worth it. At the end of the day, many of our financial decisions aren't financial at all and shouldn't be. Sending to a private school, living in a frum neighborhood, and making Yom Tov don't make a lot of sense financially, but money isn't a factor in the decision-making process. Obviously, this needs to be balanced, but there are many choices we make where finances need to be a part of the discussion but shouldn't be the final factor.