The real cost of debt

October 9, 2019

The real cost of debt is far higher than most people realize, if they thought about the real costs and consequences fewer people would carry debt.  Here’s a quick example – you are struggling to make payments on three credit cards; one has $20,000 charged on it and the other two have $10,000 each for a total of $40,000 in debt.  The minimum monthly payments are $820, and the debts will never be paid off – at least not in this lifetime.

So, you talk to your banker and decide that rather than paying $820 per month, forever, you can simply put the debt into a second mortgage.  The interest rate is 5% and with a 25 term and amortization (which you cannot do in Canada) you will pay $233 per month for twenty-five years or a total of $69,793.  But what were the charges on the cards in the first place?

Most likely the charges involved many unnecessary expenses such as eating out, buying clothes and furniture, trips and technology items that were wanted but unneeded.  Buyers remorse often comes at the wrong time – Friday and Saturday nights are the busiest times for online shopping.  At the click of an icon you can make an impulse purchase.  Monday morning you wake up feeling groggy, that was a giddy weekend, and after the cobwebs clear you realize you spent Hundreds of dollars on stuff you really didn’t need and now you don’t want – but when you call to cancel the order you find it has already shipped and the company doesn’t take returns.

Oh buy, oops fraudulent slip, I meant to say “oh boy” – that’s only part of the cost, then there’s the “lost opportunity cost” the money used to make interest payments, ad-nauseum, could be used  for other day to day lifestyle improvements, better food for example.  And, then there are the social consequences, you can’t afford to visit with family and friends, and you start fighting with your spouse about money and the stress of living on less income.

The real cost of debt isn’t simply repayment of what is owed – the interest factor alone cuts deep into the debtors income and the implications of being in debt ricochet around the rest of the debtors’ life(s). The real cost of debt, as seen in the mortgage example above is that $29,793 is chewed up on interest and removed from a pension savings plan, which even at a 3% return would grow to $51,983 over a twenty-five year term.