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Lesson 4

The Dangers of Borrowing and Banking

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Debt Video

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Is Borrowing Bad?

When you save money, you sacrifice your options today in order to have more options tomorrow.

Debt is the opposite: you sacrifice your options tomorrow in order to have more options today.

Is debt this morally wrong?

The Bible is clear that a lender should always be careful to never prey on the financially vulnerable and to protect people over property claims (Exodus 22:25, Deuteronomy 23:19-20, Luke 6:34-35, Matthew 5:42).

While a few verses hint that borrowing is dangerous to the borrower (Proverbs 22:7, Romans 13:8, Proverbs 22:26-27), there are many more verses that instruct lenders in the proper way to lend money without prohibiting its practice. Jesus’ words:

“Give to him who asks of you, and do not turn away from him who wants to borrow from you.”  Matthew 5:42, ESV

So, is borrowing morally wrong?  No.

Is borrowing wise?      IT DEPENDS

Very important to ask the question:

What are you buying with the borrowed money?

Depreciating Asset

Appreciating Asset

Debt on Depreciating Asset

A depreciating asset is something that needs to be replaced (i.e., the asset depreciates). 

People often borrow to get these depreciating assets:

Because depreciating assets need to be replaced, you must begin to save to replace them the moment you buy them.

For example, the moment you buy a car, you should start saving to replace that car.

It is unwise to buy something with debt that you need to replace since it inhibits you from saving to replace it.

For example, using debt to buy a car means that you will have to both pay the loan back and pay lots of interest. This payment will eliminate your ability to save.

 

This locks you into a cycle of debt.

  • The high interest levels help ensure that you will go deeper into the debt since debt grows exponentially.
  • Any unexpected emergency will cause you to sink even deeper, since you will keep needing to replace your car, your phone, your clothing…pushing you further into debt.

Debt on Appreciating Asset

An appreciating asset is something that is expected to grow in value over time.

People often borrow to get these appreciating assets:

Unlike borrowing on a depreciating asset, if the asset is reasonably expected to grow over time, the growth of the asset will likely match the growth of the interest payment – leaving you out of a vicious cycle of debt.

This type of debt should still be highly feared.

  • Still beholden upon another.
  • Having debt means having less options, as compared to being debt-free.
  • If you do not pay your payment, you trash your credit.
  • The asset may depreciate, which would put you in a bad place if an emergency occurs.

Make sure asset is reasonably expected to grow over 10-year period.

  • If you buy real estate at peak prices, they will most likely go down over time.
  • If you pursue a degree in art using a $100,000 school loan, your salary out of college will most likely not grow enough to keep up with the interest payments.

Repaying Debt Strategies

AVALANCHE

Most Efficient
  • High interest first.
  • Get rid of the debt that has the highest interest rate. 
  • Fastest way to pay down debt, like an avalanche is the fastest way down a mountain.

SNOWBALL 

Most motivating
  • Low balance debts first.
  • Get rid of the debt with the smallest balance first. 
  • Early success that grows exponentially over time, like a snowball rolling down a hill.

BEAR VAULT 

Both Encouraging and Efficient
  • Consumer debt first.
  • Eliminate debts from depreciating (consumer) assets first since they need to be replaced sooner than debts on appreciating assets. 
  • Bears continually raid campers’ essentials. By focusing on paying off consumer debts, you put your essentials in a bear vault, eliminating the hungry debt-bear.

SWITCHBACK 

Most simple
  • Consolidate loans.
  • Mostly useful for consolidating multiple credit card debts. Helpful for busy, disorganized people. 
  • Requires taking a consolidation loan (need good credit score).
  • Switchbacks help climbers navigate steep terrain by making the path simpler. But switchbacks often take longer.

Activity: Make a debt repayment plan

Complete Activity on PDF Worksheet (High School)

How Much Debt?

Add up all of your debt:

  1. Non-government debt will be listed in your credit report: https://www.annualcreditreport.com/
  2. Government school loan debt will be listed here: https://studentaid.gov/

Choose Repayment Strategy

If you have more than 1 type of debt, determine a repayment strategy

  1. Avalanche

  2. Snowball

  3. Bear Vault

  4. Consolidate

Model your future debt repayment:

Student Loans

Use ‘Loan Simulator’ tool to determine optimal repayment strategy.

 

Consider also using the following repayment calculator:

 

Choose the best overall repayment strategy for you:

    1. Standard
      • Default, 10 year repayment. Lowest interest, but highest monthly payment.
    2. Extended
      • 25 year repayment. Lower payment, higher interest. Minimum $30,000 debt to qualify.
    3. IBR or REPAYE
      • Payment is 10% of annual income. After 20 years, remaining debt is forgiven (forgiven debt is counted as income that year). No repaying loan early.
    4. Public Service Loan Forgiveness (PSLF)
      • If you work for nonprofit (school, church, gov’t, etc.) you simply make 120 payments that are 10% of your annual income and then remaining school debt is forgiven. Forgiven debt is not counted as income.

Banking Video

Distrust of Banks

Stu
I opened up his first checking account at 18 with my life savings of $950. I was excited about my new debit card and financial freedom. I signed up for overdraft protection since, “why not?” After a few months, I checked my balance and noticed a ton of fees. I couldn’t quite understand what was going on. I tried to be careful, but the fees just kept coming. My savings were gone now, and so much of it went to fees! I then decided to not use a bank anymore and keep my earnings hidden in my room.

AVOID OVERDRAFT PROTECTION

According to the Center for Responsible Lending, U.S. consumers paid $17 billion in overdraft and NSF fees in 2015, which amounts to $53 for every American. 

Overdraft means you try to pay for something and don’t have enough money in your account to cover the cost of that purchase.

Surprisingly, signing up for overdraft protection actually means two things:

  1. You will not know when you overdraft since your card will not be denied.
  2. You will be charged a large fee every time you overdraft your account.

Do not choose overdraft protection

Gloria
After moving to the U.S., I opened up a checking account. They told me it was free, but I kept seeing random fees. At first I didn’t really pay attenation, but my balance started to really go down. I began to pay attention and noticed so many different fees, including a service fee, paper statement fee, and foreign transaction fee. This is not a free checking account!

AVOID CHECKING FEES

The average American with a checking account pays about $8 per month in fees, but younger customers are paying a lot more. 18-25 year olds are paying $19 in fees per month in fees while 58-76 year olds are paying $2 per month, on average in checking account fees. 

76% of surveyed Americans do not pay any checking fees.
  • Ensure you have a free checking account. In order to get a free checking account you may have to maintain a minimum balance or sign up for direct deposit. Ask your bank, or change banks if they are charging you a fee you can’t avoid.
  • Only use ATMS in your bank’s network. Do not settle for ATM fees.
  • Ensure that automatic payments are scheduled after your paycheck is automatically deposited in your checking account.

TOP MISCONCEPTIONS ABOUT BANK

Banks charge fees every time you use your debit card. 

  • Not true in almost all cases.

Going to the bank takes up a lot of time. 

  • Use phone/computer for most services.

Banks exist to make a profit.

  • Not credit unions…but, having profit, within reason, simply ensures sustainability of business.

Banks charge $40 every time you overdraw your account. 

  • Mostly true, but banks will almost always credit the fee back if the first or second time.

If a bank is robbed, you will lose money.

  • All banks are insured up to $250,000.

Banks will take your house away 

  • Only if you stop paying a mortgage with them.

Choose Online Savings

Perks of choosing online savings bank

  • Much higher interest rate (sometimes 30-60 times higher).
  • A greater barrier between checking and savings boots will-power.

A few considerations

  • Make sure FDIC insured (government will pay you up to $250,000 if bank fails).
  • Transfers between savings and your checking account are free, but take 1-2 days to process.
  • Regulation D limits you to 6 withdrawals or transfers from savings during a calendar month.

Activity: Get Banked

Complete Activity on PDF Worksheet (High School)

Open Bank Account

Need:

  • Any form of ID
  • Individual Tax Identification Number (ITIN) or SSN (if you don’t have an ITIN, apply).
  • Initial Deposit

If denied:

Consider credit unions:

  • Often have better customer service, less fees, and cheaper products.
  • Must have a common bond to apply (e.g., location, vocation, membership).
  • Search credit unions in your area.

If no checking account available, use prepaid debit cards:

  • Load money onto these cards and use them to pay bills, receive paychecks.
  • Does not improve or build credit.
  • May include monthly fees.
  • Shop for prepaid debit cards

Open online savings account

  • WARNING: Usually the online bank with the highest interest rate is only offering this rate for a few months (i.e., it is a teaser rate).

Consider Community Savings Vehicle:

Build Emergency Fund

  • Start with a $300-$500 short-term emergency fund.
  • Pay off debt to increase income.
  • Work towards having at least 3 months of emergency fund savings.

If you are utilizing a California assistance program, building cash savings may impact your benefits. Use this worksheet to see if you would be impacted by building cash savings.

Transition

How do you choose between giving and saving? Are we meant to save a lot in the beginning and then give a lot towards the end of our life? What about investing in the stock market? In the next lesson we will address these questions and put all of our lessons together into one inter-personal financial plan.

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Lesson 5