Smaller Thoughts

Saw this on Digg, where people were whipping themselves into an outrage about how unfair life is, how capitalism is broken, etc.

Except this graphic is totally flawed.

Comparing annual income to total debt is apples to oranges. Suppose I make $50,000 a year and owe $250,000 on my mortgage. Is this necessarily a Bad Thing? No. Here’s why:

This comparison completely neglects the other side of the household balance sheet - assets. You borrowed $250,000 on that mortgage to buy the house, so you also own an asset (the home) worth $250,000 (putting aside the housing crash for a second). You also have likely saved some of your income each year, which is building up as an asset in your bank account. Both of these assets can be liquidated to eliminate the debt.

Another scenario - say you make $50,000 and have $100,000 in various debts. Is that a bad thing? Not if you have $200,000 saved in the bank. You can easily pay off your debt in this situation. The debt is only dangerous if it is not matched by an asset of equal or greater value.

In addition, the diagram assumes you never use any of the income you earn in the time between each bar (several years) to pay down any of the debt, yet you continue to borrow. If that’s the case, the prison is of your own making.

I could go all day, but the bottom line is, this is a completely flawed comparison.

Debt is not inherently a Bad Thing. Irresponsible debt (debt that is not counterbalanced by assets) is a Bad Thing.