Being Debt-Free Isn't Always
All It's Cracked Up to Be

FIFTY-ONE-YEAR-OLD Bruce Leckband doesn't owe any company -- or anybody, for that matter -- so much as a dime. He carries no credit-card debt, no car loan and no mortgage. (The Reno, Nev., resident is a lifelong renter.) "I've always been able to live within my means," he says, "because I save and budget -- and then I buy."

Living debt-free? In a nation where consumer debt has become as American as baseball -- thanks in part to the historically low interest rates ushered in by former Federal Reserve Chairman Alan Greenspan -- the notion sounds somewhat preposterous. Today the average student steps brightly into the working world with no less than $19,200 in student loans, according to lender Nellie Mae. Flash forward a few years, and she's soon saddled with $92,600 in mortgage debt and $9,200 in credit-card debt, according to the latest household averages from the Census Bureau's 2005 American Housing Survey and CardWeb.com.

Few take comfort in these figures. "Consumer debt is the greatest prescription for damaging your financial health," says Gary Schatsky, a fee-only certified financial planner in New York. And the problem is worsening. Consider this: Since 1995 nonmortgage consumer debt has increased 112% to nearly $2.4 trillion, according to the Federal Reserve.

Given these bleak statistics, you'd think those who manage to be completely debt-free are living on easy street. That's not necessarily the case. Living a debt-free life comes with its own unique set of challenges. After watching a debt-free friend be turned down by every mortgage lender around in part because of his lack of credit history, Leckband now reluctantly owns a credit card that he uses occasionally to keep his credit history active. The fear, he says, is that one day he may need a loan -- the four-wheel drive on his 12-year-old car has gone kaput, making him worry that a car loan may be in his future -- and he doesn't want to find his options limited. "You're expected to have debt to get debt," he gripes.

Some experts take this further, saying that living a debt-free life isn't only potentially a hassle, but can be a big financial mistake. After all, not all debt is created equal, notes Sandy Shore, a spokeswoman for NovaDebt, a nonprofit debt education and counseling group. Some debt -- mortgage debt being the classic example -- is tax deductible and gives individuals the opportunity to improve their quality of life and set themselves up for a comfortable retirement. "If you're going to have something of value when you're done paying it off, that debt is not such a bad thing," she says.

No Debt, No Credit

In an economy humming along in part because of consumers' happy embracement of debt, those who are debt-free can find themselves viewed more as pariahs, rather than role models. Most lenders consider a consumer with no credit history only slightly less risky than one with bad credit, says Craig Watts, a spokesman for Fair Isaac, the company that creates the almighty FICO score. "Consumers have proven time and again to be creatures of habit," he explains. "Without some kind of track record, the consumer is a cipher."

When John Keeling, 50, of Iowa City, decided to purchase his first home in 2005, he discovered that having no debts made lenders wary. Keeling had $40,000 to put toward the estimated bill of $83,000 ($58,000 for the one-bedroom home and $25,000 for renovations). Lenders weren't thrilled that he wanted to borrow so little, he says, and his sporadic credit card use didn't help, either. One lender even asked for an additional $2,000 fee for "security" purposes. In the end, Keeling did get a loan -- from his mother. He borrowed $25,000 from her at a 5% interest rate, and bought the house outright. Renovations are still ongoing.

Granted, in some cases, lenders are willing to look at alternate payment records, including your checking account, says Watts. But the majority still want an actual credit history. That means less favorable rates are often offered to debt-free consumers -- if credit is offered at all.

Good Debt vs. Bad Debt

After graduating from college, Robin Gagliardi, now 41, vowed to live a debt-free life. "I decided very young that I didn't want to get myself into any major debt," says the Canton, N.Y., resident. She and her husband lived for four years on his $40,000 salary, saving her $40,000 salary in order to purchase their first home outright. "We saved while our friends spent," she recalls. "We figured that house would always translate into another house."

The family stayed completely debt-free for nearly two decades. Then the couple decided to embrace a little debt in order to build the house of their dreams. Their family had now swelled to five, thanks to their three sons, and they craved more space and a gourmet kitchen ideal for family meals and entertaining. "We decided that we were OK with taking out a small mortgage," says Gagliardi, though the prospect of taking on her first major debt at age 39 scared her a bit. (Their home-owning record helped them avoid the problems Keeling encountered securing a mortgage.) To pay off their $150,000 15-year mortgage faster, the couple has been prepaying it with any extra money that comes in. After just three years, the balance is down to $79,000.

Smart move? Not necessarily, says Jason Rich, author of 'Smart Debt.' "When you actually sit down and do the math, it can actually work out in your favor to have these [good] debts," he says. Mortgage and student-loan debt are generally fairly cheap, and leave you with an appreciated asset. Plus, the interest you pay on these loans is deductible. Having this kind of debt can actually get you ahead if you invest extra cash rather than put it toward your loan principal.

Consider this: You'd pay $876 per month on a $150,000, 30-year fixed-rate mortgage with a rate of 5.76%. If you were to prepay your mortgage by an additional $100 per month, you'd pay it off six years sooner and save $42,703 in interest. Had you taken that $100 and invested it, earning a conservative 8%, you'd have $55,745 -- enough to compensate for the interest paid, plus $13,042 in profit.

Debt-Free, Cash Poor

Struggling to stay debt-free or to become debt-free can also lead to problems when you do so at the expense of saving for your future, says Elaine Morgillo, a certified financial planner based in North Andover, Mass. Continuously deferring savings -- or dipping into them -- to maintain a debt-free lifestyle could lead to serious financial woes come retirement.

"You can't exactly go back and say, 'I'd like to make up that retirement contribution from two years ago,'" says Schatsky. In other words, when tackling debts be sure to tackle other goals, like saving for retirement, at the same time. It may be the best way to ensure that you aren't looking for a loan during your sunset years.

· Check Out: More Debt Management Tips