I’d like to change pace a little on my current posts about the rental remodel and talk about debt for a few minutes.
I’ll start out by saying that I am not at all in favor of consumer debt. I define consumer debt as any debt that does not provide a return on investment. That would include cars, student loans, credit cards used for spending, vacations, etc. I don’t believe there is any valid justification for borrowing money on these types of debt (with the possible exception of funding an education that has a HIGH likelihood of gaining a much higher income, i.e. doctor, dentist, lawyer, etc.)
That being said, I know that using debt is a personal choice. I’ll still argue with you and try to convince you otherwise but in the end, it is your life and not mine and I am not going to be harmed by your use of debt.
Also, I can’t say that I am against all kinds of debt. I have borrowed lots of money to purchase the real estate that we own. Hundreds of thousands of dollars in fact. I believe that the purchase of these properties, with the use of debt, has been a wise decision and that God would say “well done good and faithful servant.” We bought most of the rental properties
We bought most of the rental properties before we bought our own home. And even in the purchase of our own house, we have a tenant in a basement apartment and we were able to shut down Keely’s offsite photography studio and move it into our own home. So while I am a proponent of debt for real estate, I am still relatively conservative with its use.
Anyway, that’s not really what I wanted to talk about, that was just to lay the basic groundwork for my opinions on debt.
What I want to address is the question: Does debt cause us to spend more? I am not even going to talk about the interest rates associated with debt…that isn’t what this post is about. It’s about the correlation between using debt and spending habits.
I have had several conversations over the past few years about the use of credit cards. The people who are in favor of using them usually have only one reason…the rewards. They get “free” stuff because they use credit cards. They get free airline tickets or free nights at a hotel, etc, etc. They say, “we pay it off every month,” thus justifying the use of credit as smart.
I have always responded with saying there are studies that have been done that show that people spend more if they are using a credit card versus spending cash. (Just google it, there are plenty of articles on the subject).
Credit card companies aren’t dumb, they don’t just give money away for the fun of it. The typical cash back credit card will have a 1% reward. But that same credit card charges the retailer about 2%. So, the credit card company doesn’t even need you to carry a balance to make money, they just need to get you to use your card on anything and everything you can. The more often you swipe, the more often they get paid.
So, it makes total sense for credit card companies to “reward” you for spending money. And all they have to do is offer a measly 1% reward and people are thrilled.
Ok, so why am I going on about this since I don’t even own a credit card? Early last year I applied for a home equity line of credit on our personal residence so that I could have access to some money in the event of a major repair on a rental or to use toward the purchase of another rental.
I didn’t use it for several months and then last summer we bought a rental that had been in the works for a couple years and had two major remodel projects on two different rentals. Without going into too much detail, I used $8,000 of the HELOC to bring the down payment up to 20% to avoid PMI on the new purchase. And I used another $25,000 to fund the remodel projects.
I, like people using debt for personal use, justified it in my own mind. The repairs were necessary to get the houses rented again and the properties would go up in value by at least the amount that was spent. So, on paper, our net worth would increase or at least stay the same even with the added debt. I also justified it because, if I had to, I could sell a property to pay off the debt or we had enough in various savings accounts that I could almost pay it all off if I had to.
It made sense on paper and I don’t think it was a foolish business move. But again, that’s not really what I want to get at with this post. I want to address the issue of how debt affects spending.
Ok, fast forward about 7 months. The balance has been paid off in full by draining any excess savings we had and by using any and all extra income every month from all sources.
There is now another unit that is in need of repair. I was originally planning on it costing about $1,500 – $2,000. But, not knowing the extent of the damage and what I would find as I started work, I knew the number might increase. In the end, this is a quick summary of what I now expect it to cost to repair/remodel the unit.
- New Fridge – $550
- New Stove – $500
- Have Floor Refinished – $1,500-$2,000
- Bathroom remodel costs – $1,000
- Other costs – $750
- Total – $4,300 – $4,800
The problem? I didn’t have $4,800 in the rental fund to cover this cost since I had used all the money to pay off the HELOC. But, you know what I thought? I figured I could just tap into the line of credit and borrow some again. After all, I was losing money by not having the unit rented right?
But, as I’ve been working on the project over the last month, I have been doing a lot of thinking. I’ve been thinking that continuing on my present course of action will lead to problems. If I am constantly having to dip into the credit line to take care of the rentals, I will always be playing catch-up. I need to get ahead of the curve by building up a proper maintenance reserve account that I can use when larger repairs come up.
I determined that would be the better course of action and I decided to try and make the remodel work without tapping into the credit line at all. You know what? That decision will save me more than $2,000 on this project and the unit will look just about the same as it would have if I had used the credit line.
What changed? My mindset. When I viewed the credit line as a fallback plan, my creative thinking went out the door. Creative thinking for me is “how can I make this work with the money that I DO have?” So, specifically, this is where I expect to see the savings.
- Fridge – I was going to spend $550 on a new one. Instead, I looked on Craigslist every day until I could find one for sale. This is a 24″ fridge so they aren’t as common. But I found one about 30 miles away and went to pick it up yesterday. Total cost $65 ($50 + $15 in gas). Savings – about $500.
- Stove – The stove was left very dirty and the handle had been broken off. But, this stove is only 2 years old. I was going to spend $500 on a new one. But I figured out I could repair/replace the handle and clean it myself. Even if it takes me all day to get that done that’s still a saving of about $500 for one day’s work.
- Wood floor refinishing – I was going to have someone else do it because I knew they would get it done faster and better than I would get it done. I figured I was going to spend $800 on flooring anyway so why not spend twice that and get hardwood floors? Well, since I didn’t have $1,500 to spend on it I did some YouTube watching and talked to a friend of mine who sanded his own floors. I’ve sanded the edges so far and will sand the main part of the room if a few days. Cost – about $250 in materials and $75 to rent the sander. Savings – at least $1,250.
Those three decisions alone will save me more than $2,000. It’ll take more of my time but even if it were to take me an entire 40 hour week that’s the equivalent of $50 an hour.
So, that got me to thinking about the remodel projects I did last year and put on the credit line. I have to ask myself, “How much less money would I have spent if I hadn’t relied on the line of credit?” I’ll never know for sure. I do know that I opted for more expensive materials. I do know that I paid to have some work done that I could have done myself. I do know that I bought new appliances when I probably could have found good used ones.
How much less would I have spent? Probably thousands.
My conclusion is that debt can rob me of coming up with alternative solutions. I still believe that debt can be used as a tool and can make smart financial sense. But with this little scenario from the last couple weeks in mind, I am going to try very hard to look for all other alternatives before resorting to the use of debt.
And I am going to stick with my resolve and my belief that the use of credit causes people to spend more than they would otherwise. I now have solid proof from my own experience. And while I can’t say for sure how other people will be impacted by using credit, I think it’s safe to assume that they spend more as well.
What about you? Are you spending more by using debt?