This article is the fifth in a series of seven that will discuss our approach to reaching financial independence, and determining key criteria for success. If you have not already read the fourth step regarding test-driving with one less income, please take a minute to visit that post.
This article will discuss reasons for becoming debt-free before retirement.
In Step 1, we outlined the many benefits of setting up a budget to take control of your financial life. In Step 2, we discussed why it is important to have a side hustle and create a passive income. In Step 3, we covered the need to plan for replacement and maintenance costs in the journey toward financial independence and retirement.
Last week, Step 4 explored the concept of “test driving” living on less income.
These steps highlight the fact that, if we do not manage expenses and design income sources independent of work, we may be choosing a long and rough road to financial independence. Now it’s time to look at the impact of debt freedom on our early retirement plans.
Debt keeps you chained to commitments.
A simple trip to the car dealership has brought plenty of excitement in my life. The idea of buying a new, pre-owned car with all the bells and whistles gets the adrenaline and endorphins flowing. However, each time I purchase a vehicle, I have invited new debt. I have paid cash on a few occasions for vehicles in my car-buying history. When not paying in cash, I have paid them off quickly, but either way I have taken on new debt, a payment, and a hit to our budget.
These debts bind us and take options away from our financial future. The reality today is that most people in America have become accustomed to a house payment, one or two car payments, at least one credit card bill, and usually one other form of credit obligation. In addition, for those just finishing college, student loans can make up a large percentage of debt and can be difficult to manage.
“Credit is a system whereby a person who can’t pay, gets another person who can’t pay, to guarantee that he can pay.” ― Charles Dickens, Little Dorrit
Debt has some unintended consequences on the rest of our financial picture. Each debt:
- Forms a contract and obligation to repay the money originally lent to us for our purchase
- Becomes an expense line in our budget, taking us away from saving and investing
- Can further limit us in our options to buy a home, invest in a business, or leave behind our jobs for the work we crave
- Requires reading and understanding statements
- Includes paying interest
- Can further complicate our taxes with mortgage deductions
- Requires us to work longer
What if your income stream dried to a trickle?
When we engage in activities that bring on debt, such as buying a McMansion for a household with 2.79 people, we are creating new obligations for our money. In the years of earning and throwing caution to the wind, it is easy to justify these purchases.
We have the income sufficient to make those payments so we are able to convince ourselves we “can afford it.” Better yet, “We deserve it!” We all work hard and you only live once, so why not live for the day? This works well until there is a bump in the road. The recent stock market tumble is a great example of a bump.
If you have planned for those bumps and have an adequate E-Fund, then you can probably weather the storm. What happens if you have already retired and you are relying solely on one or two passive income streams? Let’s assume you are not eligible to draw on your Social Security or a pension since you are only 39 years old.
You might need to find a job.
You may be thinking, “Wait a minute, I worked all those years and now something goes wrong and you are telling me I need to get a job?” Yes, that could happen.
This is a challenge for some of us who are over 35: our ability to get that next job. This is true especially if we have been out of the market for some time. Not having debt makes it easier to focus on bringing new income.
Another option would be to cut back on your lifestyle. Finding yourself with your income diminishing would be a great opportunity to re-evaluate your budget, cutting out any new fat that has grown on your expense waistline. Maybe you need to delay replacements or bucket list items for a few years. You could cut broadly across all areas to get your spending back in line with income.
Acquiring debt is simple. Escaping it can be difficult.
What would be wrong with becoming debt-free prior to financial independence or retirement? This is something that not many people accomplish until later in life. Why not strive to be different from the norm—in fact, to become “weird”—attempting to live a life without owing money to others?
Unfortunately, the trend is for people in their sixties to retire with a mortgage and car payments. When you couple that with retirement account balances of only around $100K, you have the makings of a perfect retirement storm.
It is freeing to be in a position that does not require continuous payment for past lifestyle choices and purchases. For us, paying off our mortgage was a huge goal that we were able to accomplish this year. That has put us in a position of strength, with only a small amount of rental real estate debt remaining until we are completely debt-free.
“Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.” ― Charles Dickens, David Copperfield
We have been on this debt snowball for so long that it would be difficult for us, emotionally, to borrow money again. Difficult yes; impossible no. 🙂 At least we have more options by eliminating the remaining debt. We could buy our own version of a McMansion someday.
If we feel compelled to have debt, we can always rush back in and get some—it is very easy to do. We can rush back to the feeling of being stuck, working our jobs to pay our creditors.
We are choosing to do what is difficult instead of easy. It shows our commitment to a life we want to live, unique and nontraditional, away from the 9-to-5-to-age-65 crowd.
Becoming debt-free is not required, so why make things difficult?
We have discussed the importance of budgeting, managing expenses, saving, investing, passive income, planning for replacements and bucket list costs, and test-driving living on less income. In this step, we’ve reviewed the reasons that becoming debt-free prior to early retirement could be an excellent idea.
We are choosing to enter our retirement completely debt-free. We feel this will give us additional safety in our planning—the equivalent of bringing on another passive income source. Paying off debt is a lot easier than creating a new passive or active income stream to bring in money.
Next week’s Step 6 continues this retirement progression. We will discuss how we are determining when we have arrived at financial independence and “have enough” to retire. Thanks for stopping by and continuing with the series.