Why Debt Is the Enemy of Financial Independence
The Flip Side of the Coin
You may have noticed I took a week off. It was a bit forced since I went on vacation in the Rockies with very little cell service! Hiking/camping/fishing and similar outdoor activities are great for a digital detox and are solid options for saving money too. We can cover that in a future post. For now, on to debt!
We've mentioned investing: putting money to work so it can grow and eventually support your financial independence. Today we need to discuss the opposite: debt.
Debt is anti-investing. While investing makes compound interest work FOR you, debt makes compound interest work AGAINST you. They're two sides of the same mathematical coin, but one builds wealth while the other destroys it. Debt is a financial emergency! Stop! Do not pass go!
Understanding this relationship is crucial for your FI journey, because debt doesn't just slow your progress. It can make financial independence mathematically impossible.
What Debt Really Costs You
The Double Burden
When you have debt, you face two problems simultaneously:
1. Money leaving your pocket: Interest payments that provide no benefit
2. Opportunity cost: Money that could be growing in investments instead stays trapped paying off past consumption
Example: $10,000 credit card debt at 18% interest costs you $1,800/year in interest payments. But it also costs you the $700+/year that $10,000 could earn if invested at 7% returns.
Total annual cost: $2,500+ in wealth destruction
The Compound Interest Reversal
Remember our compound interest examples showing how $100 becomes $761 over 30 years at 7% returns? Debt works the same way, but in reverse.
Credit card debt example:
• $5,000 balance at 18% interest
• Making minimum payments (2% of balance)
• Time to pay off: 44 years
• Total paid: $19,332
• Interest cost: $14,332
That $5,000 purchase actually cost you nearly $20,000 in total! (Money that could have been working toward your financial independence instead.)
Types of Debt and Their FI Impact
The Debt Hierarchy (From Worst to Best)
Note: interest rates will vary based on your personal credit risk (typically determined using a credit score), but also current rates for other types of debt. For example, mortgage rates are usually calculated by adding a premium to the 10-year treasury rate. This means your interest rate can increase even if you improve your score.
Credit Card Debt (Worst)
• Interest rates: 15-25%+ annually
• No tax deductions
• No asset backing the debt
• Minimum payments designed to keep you in debt forever
Personal Loans
• Interest rates: 6-15% typically
• Fixed payments (better than credit cards)
• Still no tax benefits or appreciating assets
Car Loans
• Interest rates: 3-8% typically
• Asset depreciates rapidly
• No tax deductions
• Keeps you trapped in a monthly payment cycle
Student Loans
• Interest rates: 4-7% typically
• Some tax deductions available
• Can't be discharged in bankruptcy
• Sometimes necessary for career advancement
Mortgage Debt (Best of Bad Options)
• Interest rates: 3-7% recently but much higher in the 1970s and 1980s.
• Tax deductible (sometimes)
• Backed by appreciating asset
• Lower rates due to collateral
Why "Good Debt" Is Still Bad for FI
People often talk about "good debt" vs. "bad debt," but from an FI perspective, all debt slows your progress.
Even mortgage debt:
• Requires monthly payments that reduce your savings rate
• Interest payments are money not invested
• Ties you to a specific location
• Creates financial obligations that make early retirement harder
I am not saying you should be a renter forever. The rent vs buy calculation is complicated, but buying does make sense in some areas of the country. However, mortgage debt is still debt! If you stop paying it, the bank will take your house. Additionally, houses prices do not always go up! (Ask anyone who bought a home in 2007.) You may end up owing more than your home is worth. Don’t automatically assume mortgage debt is “good”.
Advanced: If you can use debt to acquire appreciating assets at interest rates lower than your investment returns, you should. However, this requires careful analysis and carries real risks. If you own a business and the debt allows you to expand, it could pay off. The key is that this debt is used against productive assets, not householde purchases.
The Math That Shows Why Debt Kills FI
Scenario Comparison
Let's compare two people with identical incomes but different debt situations:
Person A (Debt-Free):
• Income: $60,000
• Expenses: $40,000
• Available for investing: $20,000/year
• Savings rate: 33%
Person B (With Debt):
• Income: $60,000
• Expenses: $40,000
• Debt payments: $10,000/year
• Available for investing: $10,000/year
• Savings rate: 17%
Results after 20 years:
• Person A: $877,304 invested
• Person B: $439,652 invested
Both Person A and Person B need $1M to reach financial independence. Look at the difference avoiding debt made! Person A reaches FI 7+ years earlier simply by not having debt payments.
The Debt Payoff vs. Investing Decision
"Should I pay off debt or invest?" This is one of the most common questions in personal finance.
The mathematical answer: Pay off any debt with interest rates higher than your expected investment returns.
The practical answer: Pay off all non-mortgage debt before investing (except for employer 401k match).
Why the practical answer is different:
• Guaranteed return: Paying off 15% credit card debt gives you a guaranteed 15% return
• Psychological benefit: Being debt-free reduces stress and provides mental clarity
• Cash flow improvement: Eliminates monthly payments, increasing your savings rate
• Risk reduction: No debt means no payment obligations during market downturns
How Debt Traps Work
The Minimum Payment Trap
Credit card companies design minimum payments to keep you in debt as long as possible:
• Minimum payment calculation: Usually 2-3% of balance
• Payment allocation: Most goes to interest, little to principal
• Payment reduction: As balance decreases, so do minimum payments
• Result: Debt takes 15-30+ years to pay off with minimum payments
The Balance Transfer Shuffle
The pitch: "Transfer your balance to 0% interest for 12 months!"
The reality:
• Transfer fees (3-5% of balance)
• Promotional rate expires
• New purchases at high rates
• Easier to accumulate more debt
The Debt Consolidation Mirage
The pitch: "Combine all debts into one lower payment!"
The problems:
• Lower payment often means longer term
• Total interest paid usually increases
• Doesn't address spending behavior
• Frees up credit for more debt accumulation
The Psychological Impact of Debt
Stress and Decision Making
Debt creates constant psychological pressure:
• Sleep problems: Financial stress affects sleep quality
• Relationship strain: Money fights are leading cause of divorce
• Career limitations: Can't take risks or negotiate from debt
• Mental bandwidth: Constant worry about payments reduces focus
The Debt Mentality vs. Investment Mentality
Debt mentality:
• Short-term thinking
• Focus on monthly payments
• Comfort with owing money
• Spending money you don't have
Investment mentality:
• Long-term thinking
• Focus on growing wealth
• Comfort with delayed gratification
• Only spending money you have
These mindsets are incompatible. You can't build wealth while simultaneously destroying it.
The Emergency Fund Exception
Before aggressively paying off debt, build a small emergency fund ($1,000-2,500). Here's why:
Without emergency fund:
• Unexpected expense → more debt
• Creates debt spiral
• Undoes payoff progress
With emergency fund:
• Unexpected expense → use fund, rebuild it
• Prevents new debt
• Maintains payoff momentum
Debt Payoff Strategies
The Debt Avalanche (Mathematically Optimal)
1. List all debts with balances and interest rates
2. Pay minimums on all debts
3. Put extra money toward highest interest rate debt
4. Repeat until all debt is gone
Example order:
1. Credit card (22% interest)
2. Personal loan (12% interest)
3. Car loan (6% interest)
4. Student loan (4% interest)
The Debt Snowball (Psychologically Optimal)
1. List all debts by balance size
2. Pay minimums on all debts
3. Put extra money toward smallest balance
4. Repeat until all debt is gone
Why it works: Early wins provide motivation to continue
Which Strategy to Choose?
• Debt avalanche saves more money mathematically
• Debt snowball provides more psychological wins
• Choose based on your personality: Do you need motivation or optimization?
Both strategies work. The best strategy is the one you'll actually follow. Naturally, I recommend paying off credit card debt first if you can because it has the higher return, but if you have $10k in credit card debt and only $500 left on your car, I understand the excitement of receiving the title in the mail. Paying off any debt is positive!
Mortgage Debt: The Special Case
When to Pay Off Your Mortgage Early
There is no right answer to this because two rational people can have a difference preference.
Consider paying off early if:
• Interest rate is above 6% (because the difference between investing in your mortgage and the stock market is small)
• You're close to FI and want guaranteed cash flow reduction
• You value the psychological benefit of being completely debt-free
• You're nearing retirement and want housing security
Consider keeping the mortgage if:
• Interest rate is below 4%
• You're early in FI journey and have limited investment capital
• You're getting tax deductions that lower effective rate
• You can invest the difference at higher returns
Mathematically, the answer is usually to avoid paying off the mortgage early and trapping your savings as home equity. That said, some people prefer to own their home outright because it greatly improves cash flow and there is a mental benefit in knowing you can’t be evicted for not paying a mortgage you don’t have!
How to Prevent Future Debt
Mindset Shifts
From "afford the payment" to "afford the purchase":
• Don't ask "Can I afford $500/month?"
• Ask "Can I afford $30,000 cash?"
From "monthly payment thinking" to "total cost thinking":
• A $25,000 car financed at 6% for 5 years costs $28,999 total
• That extra $3,999 could be invested instead
From "building credit" to "building wealth":
• Credit utilization for credit score: Keep utilization under 10%
• Wealth building: Keep utilization at 0% by paying in-full
Practical Systems
Emergency fund: Prevents debt for unexpected expenses
Sinking funds: Save monthly for known future expenses (car replacement, vacation, home repairs)
24-48 hour rule: Wait before any purchase over $100
Cash-only periods: Use only cash/debit for 30-90 days to reset spending habits
The FI Timeline Impact
How Debt Extends Your Working Years
Using our savings rate calculator, here's how debt payments affect FI timelines:
40% savings rate: 19 years to FI
30% savings rate: 24 years to FI (+5 years)
20% savings rate: 31 years to FI (+7 years)
If 10% of your income goes to debt payments, you've effectively moved from a 40% to 30% savings rate, adding 5 years to your working life.
The Acceleration Effect of Debt Freedom
Once debt is eliminated:
• Immediate cash flow increase: All debt payments become available for investing
• Psychological freedom: Less stress improves decision making
• Risk tolerance: Can take more investment or career risks
• Geographic flexibility: Not tied to high-income areas to service debt
Getting Started with Debt Elimination
Week 1: Debt Inventory
• List all debts with balances, minimum payments, and interest rates
• Calculate total monthly debt payments
• Choose avalanche or snowball strategy
Week 2: Budget Optimization
• Find extra money for debt payments
• Cut unnecessary expenses temporarily
• Consider side income to accelerate payoff
Week 3: Automate the Plan
• Set up automatic payments
• Automate extra payments to target debt
• Remove temptation by removing payment cards from wallet
Month 2 and Beyond: Execute and Track
• Stick to the plan regardless of motivation
• Track progress monthly
• Celebrate milestones to maintain momentum
The Bottom Line
Debt is the enemy of financial independence because it forces compound interest to work against you instead of for you. Every dollar that goes to interest payments is a dollar that can't grow into your future freedom.
The math is clear: debt extends your working years while debt freedom accelerates your path to FI. The psychological benefits of being debt-free like reduced stress, increased flexibility, better decision making, are just bonuses on top of the mathematical advantages.
You cannot build wealth while simultaneously destroying it through debt payments.
The good news? Debt elimination provides immediate, guaranteed returns equal to the interest rate you're paying. It's one of the few guaranteed investments available, and the psychological benefits compound just like the financial ones.
Next time, we'll talk about credit cards, the most dangerous (and abused) form of debt.
Until then, your homework: List all your debts with balances and interest rates. Calculate how much you're paying annually in interest and what that money could become if invested instead. The numbers might shock you into action.
Here's to making compound interest work for you, not against you,
Max
Remember: Every month you stay in debt is another month that compound interest works against your financial independence. The fastest way to start building wealth is to stop destroying it through debt payments.