Debt Creates Money; Where Does it Go? Part 3
What are a consumer’s options in a debt-based economy?
Est. Read Time: 9 min
Prologue
Step 0: Identify the debt burden
Step 1: Eliminate/Reduce non-asset backed debt
Step 2: Build a credit score
Step 3: Become a business
Conclusion
Prologue
9.6 million consumer bankruptcies over the past 10 years. That equates to 4-8% of US adults who have filed for bankruptcy in the past 10 years, depending on whether those who filed were married or not.
Contrast that experience of debt with the experience of an owner of a Real Estate firm who demonstrates in an in-depth twitter thread how to utilize debt for significant profit. He describes in detail an example of how you can, without putting up any of your own money, use debt and investor funds to buy a million dollar property and after two years end with over 25% ownership and investors paid off.
This comparison is in no way meant to demonize the business owner but instead highlight the takeaway from last week’s article. The debt-based US economy asymmetrically punishes large swaths of Americans while benefiting others.
In Part 1 we described the logic of a debt-based economy. Part 2 went into full accounting of our debt-based system, demonstrating that our system forces the government to use debt to prop up consumers while consumer interest rates are more than twice the interest rate of the average business.
Now in Part 3, it’s time to find options consumers can use to tip the scale in their favor.
Step 0: Identify the debt burden
If we focus on symptoms rather than the disease, then the symptoms will simply re-appear.
If we focus on consumers shifting from being crippled by debt to profiting from debt rather than first identifying how/why people get crippled in the first place, then our consumer debt burden will simply re-appear.
Since we started the discussion with bankruptcies, here are the top 4 stated reasons for bankruptcy:
Income loss
Medical expenses
Unaffordable mortgage
Living beyond means
To give further context for some of the income loss, as of the beginning of January 2021:
25M (10% of US adults) are unemployed
43M (17% of US adults) are on SNAP (food stamps)
89M (35% of US adults) couldn’t buy enough food for their most recent week
To give further context for medical expenses:
The average consumer has $5,000 in medical debt
20% have over $50,0000
For reference, the average U.S. annual salary is $52,000 while the median is $34,000. And as of 2016, according to the Federal Reserve, the average savings balance is $31,000 while the median is $7,000.
This means that one bad medical visit could wipe the typical American’s savings, sometimes multiple times over. And if you are unemployed or struggling with food already, there very well may be no savings account at all.
In the next sections we will discuss ways in which medical debt can be mitigated and how to address other debts more in one’s control. But it’s important to note, that with the way our current healthcare system is structured, some people will be forced into bankruptcy with no recourse. They can follow all of the following recommendations, make sensible decisions, and still be forced into bankruptcy due to one medical emergency.
Step 1: Eliminate/Reduce non-asset backed debt
The only way for average consumer interest rates to equal business interest rates is to completely eliminate all debt that isn’t property debt. Credit card debt, medical debt, payday loans, all need to be removed from consumers’ accounts.
But as we just saw, this is easier said than done. Moreover, many businesses make money from offering advice to those in debt, so finding advice while avoiding being preyed on can be challenging.Below, I’ll cover two strategies for reducing non-asset backed debt, but for more free insight into recovering from debt, here’s a link to a community of almost 9,000 people helping each other with their debt.
REDUCE OR POSTPONE DEBT THROUGH NEGOTIATION
Sometimes debt is up for debate. For example, with medical debt and credit card debt, if you go through the process of negotiation you can often reduce a large amount of your debt. By at least one account, it’s possible to eliminate your medical debt load by over 70% through negotiations.
REDUCE DEBT INTEREST THROUGH CONSOLIDATION
Often, interest rates are the most crippling burden of debt. As an example, let’s say you have $10,000 in credit card debt at 25% APR, but you can only pay $210 per month towards that debt. At that rate, it will take you almost 24 years to pay off that debt. However, if you can get a different loan of $10,000 with an interest rate of 10%, this can be paid off in 5 years while paying the same monthly amount.
The idea of consolidation is to use that second loan to pay off your first loan and effectively change your interest rates to something more manageable.
In practice, this may look like taking out a personal loan or taking on a credit card with an intro 0% balance transfer and APR. Unfortunately, this option is best suited for those with good credit as those without may not find any rates that are better than your highest. For those people with lower credit scores, credit unions on average provide a 1% lower interest rate than banks, so that may be worth looking further into.
Step 2: Build a credit score
As shown in last week’s article, on almost every form of debt, a bad credit score leads to paying at least twice as much interest on debt as a good credit score. Furthermore, a good credit score will help you reduce/remove your non-asset backed debt by opening up opportunities for debt consolidation. And even if you want to avoid debt when possible, only 16% of homeowners could buy a home without a mortgage, so 84% of people will need to rely on debt eventually. When you do, you want your interest rate minimized, so you need a good credit score.
So how does one acquire a good credit score?
If you’re a parent, you can add your child as an authorized user to your credit card as young as 13. As long as both of you use the card responsibly, this can help your child with a positive start.
If you are 18 years or older with no credit experience, then either student loans or a secured credit card/loan will be your best bet. Student loans were explained in depth in last week’s article, but secured credit cards/loans involve you keeping $X in your bank and taking on at most $X amount of debt. If you end up being unable to pay your debt, the bank simply closes your card/debt and takes the $X in your bank account.
Important to keep in mind, the top three most important aspects of a credit score are:
(35% of the score) How consistently you pay on time
(30% of the score) How much credit you have unpaid (balance on your credit card)
(15% of the score) How long your lines of credit have existed
Understanding your own psychology is crucial for this point. If you know that you can’t be trusted to pay off a credit card in full by the monthly due date, don’t get a credit card.No credit is better than bad credit. If you want to build credit with an alternative to credit cards and you feel like you can trust yourself with a $300 secured loan instead, this can still be enough to set you up to have a good credit score.
If you’re able to achieve everything up to this point, removing non-asset backed debt and only taking on debt while having a good credit score, consider this a massive victory. That alone is enough to reduce the burden consumers suffer from debt.
If you are willing and able to take the risk, the next step enables consumers to start actively tipping the scale in their favor.
Step 3: Become a business
If you, a consumer, declare bankruptcy, then all you own can potentially be seized. If a business were to declare bankruptcy, then for the most part only what the business itself owns can be seized. This means that the business owner’s property as well as their personal money wouldn’t be touched.
This fact alone might be enough incentive to want to start a business.
Forming your own business is not for everyone, but know that anyone can form a business. Any individual person can file the paperwork to form a Limited Liability Company and effectively become a business.
It does cost money. It does involve paperwork. But if you are in the position to become a business, it can give you a significant leg up in dealing with debt and taxes.
LIMIT LIABILITY
If you, as a business, take on debt, then none of your personal assets are at risk. There are some actions you need to take to guarantee this, like maintaining a business bank account, but doing so will let you take out debt without risking your house or your money.
As an example, let’s say you own both a home and a rental property. If you don’t own the rental property through a business and you become unable to pay its mortgage (e.g. you can’t find a tenant), then you risk losing both your rental property and your personal home. If you own the rental property through a business, you risk, at most, losing the rental.
LIMIT TAXES
If you use your car, part of your house, or travel for your business, you can claim the money you spend as business expenses. All of the money spent on business expenses can be written off on your taxes. These aren’t my words, these are the words of the IRS.
So if you made $100 with no business expenses and tax rate of 10%, you paid $10 in taxes.
If instead, you claim $50 spent on your car as a business expense, your taxable income is $50 and only that amount is taxable, resulting in you only paying $5 in taxes.
In both cases, you make the same amount of money and spend the same amount of money on your car as you otherwise would, but by marking them as business expenses you pay 50% less in taxes.
PROFIT FROM DEBT
When I first heard you could use debt to make money, I didn’t understand. I understood that you use the debt to buy something that makes more money than what you would spend on interest, but I didn’t know what that actually looked like.
The catalyst for my understanding was seeing examples. Immersing myself in a community of people doing what I wanted to learn, and learning from their examples.
These are the top three examples that I’ve seen so far:
How you can use debt to conduct a real estate deal with zero prior experience and no money
How you can use debt that requires no payoff for the first 6 months to buy a small business
Before you consider using debt for profit, do your own further research, but my hope is that this article opens the door to get you started.
Conclusion
$14T consumer debt vs $10T business debt. Taking the actions mentioned here, America could maintain the same level of economic growth, the same amount of total debt, but pivot more of the debt burden away from the average individual. Additionally, the more consumers who create businesses through debt, the lower the unemployment rate and the fewer people risking bankruptcy. As an additional benefit, the government would have less need to spend government debt supporting consumers.
Within our debt-based system, consumers taking these actions would lead to an improved outcome for consumers as a whole.
However, there is no reason for us to be obligated to a debt-based economy. As mentioned in the first article, the logic behind why we ground an economy in debt is because we need to create new money to avoid deflation yet not so much as to trigger hyperinflation.
Debt provides one solution to our economic problem, but this solution isn’t the only one. Another solution, bringing its own pros and cons, is cryptocurrency.
In next week’s article, we will evaluate the viability of cryptocurrency as an economic solution.