Should debt be a part of your budget?
Jordann over at My Alternate Life brought up an interesting point, saying that debt should not be part of your budget.
It clearly shows debt as part of a balanced budget. I think this sends entirely the wrong message.
This pie chart makes it seem like debt is normal, and the truth is, for the vast majority of North Americans, it is.
For most people, there will always be debt, whether it’s a car payment, student loans, or a mortgage, debt is constant.
For the record, it’s this bad boy:
While I really like her point about debt not being seen as “normal”, the reason why a lot of budgeting sites (including mine) shows debt repayment as 15% of your budget is for a few reasons which I’d like to list out and clarify:
1. PEOPLE WHO BUDGET FOR THE FIRST TIME ARE CLUELESS
I was, anyway. Maybe I’m dumber than most (very likely) but about 10 years ago, I didn’t even know what a budget was.
I didn’t have a budget and I didn’t even know where to start, so I looked at the given pie chart and went: Ah hah!
I built a preliminary budget based on those percentages and then tweaked it depending on how I lived.
For instance, my housing was outrageous. I was paying something like $1600 a month for an apartment and it was more than 25% of my net income, around 38% at the time!
When I saw that my housing should really roughly be around 25% and I was over by a good 13%, I got rid of the apartment, turned into a minimalist and yadda yadda…
2. THE PERCENTAGES ARE JUST GUIDELINES SO YOU DON’T BURN OUT
15% for debt repayment is low but reasonable, but don’t forget that the budget also says to put 10% towards savings.
Let’s say you have $2000 a month to budget
15% of that is $300. That’s a reasonable amount to put towards you debt (assuming the minimum payment is less than $300 of course), and it still leaves you about $1700 to cover everything else.
Debt fatigue is VERY real, and a lot of people when they first start getting out of debt (myself included), get super excited and ambitious about clearing it ASAP… without realizing that 5 years is a long time to be living without any fun.
3. COMMON SENSE DICTATES WHATEVER MONEY IS LEFT OVER, SHOULD GO ONTO YOUR DEBT
When I was getting out of debt, I saw the budget percentages, followed them for a few months then I ignored all of that later on and put 90% of my money towards my debt because I could.
I was able to do this because I became a modern nomad, living out of hotels working on projects in different cities, but I never once thought:
Hey, 15% for debt, that’s all I’m going to pay towards it!
… but if I had originally set my targets to 90% to go towards debt, or even 25% while paying rent and buying groceries, I would have felt trapped and undoubtedly burned out from repaying it to the point where debt fatigue sets in.
4. NO ONE IS SUGGESTING TO TAKE ON MORE DEBT TO “BALANCE A BUDGET”
The point that Jordann makes which I think should be clarified is that no one is saying you should take out a car loan, get a mortgage or take out student loans to have a “healthy” budget.
If you don’t have any debt, you’re at the peak of financial health. Stick that 15% for debt into savings, and ramp your savings up to 25% every month (or more, if you can hack it).
5. IF YOU ARE THINKING ABOUT BUDGETING, YOU ARE PROBABLY IN DEBT
My last point is that I never had a budget before I graduated and started working because I wasn’t technically in debt.
Yes, I was in school, racking up student debt, but it didn’t become real to me until I graduated, got a job, and got a piece of paper in the mail saying I owed $60,000 with the minimum payment being $_____ charging a rate of ____% a day. (!!)
It was at that point that I realized that I should probably start learning how to manage my money so I could pay for rent, food and my debt.
12 Comments
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save. spend. splurge.
It’s also to help you figure out a balance without making you cry because you budgeted only 5% for food. 😛
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Aleksie
I don’t see why you wouldn’t include debt into your budget, unless you somehow have someone else paying it off for you. I always assumed a budget was for anything you have to pay for, followed by some wants.
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save. spend. splurge.
The point was more that if debt HAD to be in the budget forever as part of a healthy budget.
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Aleksie
I guess I’m not seeing the point entirely. It seems odd that one would budget as though budgets are static. I don’t have children, for instance, so children are not part of my budget; should I ever have a child, I’d have to include him/her in the budget. I also hope to make more money, so the percentage of my income would change for particular items.
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save. spend. splurge.
I see what you mean, but she made that point that she thought if someone didn’t have debt, to have a “balanced budget” they’d have to go out and incur debt to include it as part of their budget (as per the teachings of the pie chart).
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Charles@gettingarichlife
Some people, consider paying back debt as part of their savings rate as it’s reducing what they owe. So if you save 10 percent and your debt repayment is 15 percent the principle part being 5 they consider that a 15 percent savings rate. I disagree with that viewpoint as paying back debt is still spending money. No difference between buying something and paying for it today or over months. Means someone whose a spender with high credit card debt would have a high savings rate as they’re always paying debt back
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Dayle
I agree with you, however I consider the extra payments I make towards my mortgage as savings. The money going directly off the principal, I see it as money in the bank. I don’t have any other debt. And the mortgage payment amount I “have to” make I consider that part as housing. Thoughts?
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save. spend. splurge.
I wouldn’t agree with this. The money you are paying to your mortgage is not 100% interest-free. You are paying interest in there, so it’s lower than your mortgage payment.
Also, it is a kind of “forced savings” in a fixed asset, but as you didn’t buy that house in cash outright, you don’t own the house — the bank does — and you pre-spent your future earnings / cash on a house by borrowing the money.
At the end of your mortgage, then it all flips to you having that money invested in the house, but as it stands now if you were to default on your payments (not to say that you would), who would get the house? The bank, right? You wouldn’t get the money back that you’ve “saved” into the equity of your home.
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tomatoketchup
Paying back debt is not saving; it’s delayed spending. If credit didn’t exist, you would have had to pay for all that stuff with cash up front (which is probably a better idea anyway for people with money problems). For me, the only debt that has ever been acceptable is a loan for education that will result in a proportionally higher paycheck later in life.
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save. spend. splurge.
Whoa, great minds think alike. I replied to the other two comments with pretty much the same logic.
I agree with student loans being the only debt that is acceptable to call a true investment, assuming of course, you don’t go $100,000 into debt for a degree that will be pretty much useless when you graduate, thereby saddling you with debt and not increasing your paycheque.
I’ve used this same logic to decide to NOT go back to school for an MBA. I wouldn’t get more money in my field with an MBA, so why spend the $100K?
(My brother also had the same train of thought and it is why he doesn’t have an MBA either.)
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save. spend. splurge.
I can’t agree with this. Paying back debt is paying back debt, not saving, even if it’s helping reduce the principal and avoiding higher interest costs.
Paying back debt is spending because you incurred that debt as you did not have the cash to buy it outright, so you pre-spent the cash ahead of time.
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Lisa E. @ Lisa vs. the Loans
Whenever I suggest a percentage based budget to friends, they start to freak out if their actual spending doesn’t perfectly fit. But you’re right – the percentages are just a GUIDELINE. If you want to pay MORE towards debt, go for it! If you need to cut back, that’s fine, too! The purpose of the percentage based budget is to show that if you spend more toward one category, it should directly affect all the others. It isn’t meant as a verbatim plan.