The other day a friend told me that he bought a house. And then he corrected himself and said, “Actually, the bank bought a house. They’re letting me live there while I slowly repay them.” It got a good laugh from the group and is right on point. It started me thinking about all the ways the lawyers lock themselves in to various debt that seems “normal” including debt that is much worse than a mortgage.
I spend a lot of time on financial forums and it’s not uncommon for a high earner to list their income and expenses and ask for advice. It always make me scratch my head when I see a lawyer explain that they’re making $120K a year and then list expenses like “$8K car loan” or “$2K credit card debt <—— We HATE this debt”.
Why are these lawyers choosing to essentially work for the bank? Bank shareholders grow rich each year thanks to these lawyers who are willing to spend a few extra hours at the office so they can pay unnecessary interest to a bank.
Here’s a few that come up rather frequently:
Credit card debt
I bet that you didn’t know that the big box on every credit card offer that comes in the mail is called the Schumer Box, named after Senator Chuck Schumer. Yet, it’s hard to miss the box because the law requires it to be in 18 point font. There’s no hiding the relevant information in small terms and conditions text when the law mandates a big box with the interest rate prominently displayed.
Assuming you’re familiar with the box, you’ve probably noticed that credit cards charge between 15% – 30% interest. Do you know of any investment return that pays a 15% – 30% return? If I did, I’d buy as much of it as I could. If you’re paying interest – even for a month – at that rate, you are someone else’s awesome investment. You are single-handedly funding their house in the Hamptons or yacht purchase.
If you’re making a decent salary, there’s absolutely no reason to carry credit card debt even for a day. If you find yourself paying interest from time to time, you have a cash flow problem that can be fixed with some simple budgeting.
Debt and an emergency fund
Even more perplexing, you’ll sometimes see a post that lists a small amount of credit card debt along with a $5K emergency fund. The point of an emergency fund is to keep you from going into debt (if you even need one), so it defies logic to carry high interest debt and an emergency fund at the same time. Lawyers generally have access to plenty of credit opportunities. If you have an emergency, you should be able to use a credit card (or other line of credit) to fund the emergency. If you have credit card debt, you already have an emergency. One that needs to be fixed immediately.
Car loans are the most likely payment to see listed on an income/expense report. If you’re grossing $10K – $15K a month, how long could it possibly take to pay off a $5K car loan? A lawyer’s status symbol shouldn’t be driving a fancy car while carrying a loan. It should be driving a paid-off car. The idea that you’re gaining some type of arbitrage by borrowing at 1.9% and investing the difference doesn’t hold water. You’re either not disciplined enough to follow through with this at the level of precision needed to make sure you don’t mess up or you’re spending way too much time trying to squeeze out a marginal return, when you should be focused on increasing your savings rate. Broke people have car loans.
Long student loan repayment terms
Whenever I talk to a lawyer about repaying their student loans, I try to convince them to pay off the debt in 5 years. It’s like ripping a band-aid, the sooner you’re out of debt the better. The student loan refinance companies know the reality on the ground though. Those of you that are refinancing law school loans are taking 10 year or 15 year terms. I’d rather that you were debt free as soon as possible but I admit it’s hard to convince a lawyer to buckle down and knock out the debt when there are a lot of competing demands for your dollars.
But if you do take a longer term loan, you’re not getting the best deal. You’ll pay a higher interest rate. And, if we’re talking about the difference between a 5% fixed and a 2.5% variable, that will be a significant amount of lost money. Worse, you’ll still be in debt 10 or 15 years later. Who wants that? I don’t know too many lawyers that are more excited to be practicing law after spending 10-12 years doing so. Do you really want to be in student loan debt at 48 if you don’t have to be?
Keep in mind that having debt for the next 10-15 years isn’t just a problem for burnout. It’s a problem because there will be so many other things going on in your life, such as kids, wanting to move to a new location, thinking about cutting back hours, etc. Will you be able to enjoy / do those things if you still owe the student loan companies?
30 year mortgage
Have you ever wondered where the 30 year fixed mortgage came from? Why 30 years? It didn’t always use to be that way.
Mortgages used to be short-term loans from banks to buy houses. But after the Great Depression and WWII, the government stepped in and started buying mortgages from banks to facilitate lending to returning vets. The government assumed those vets would work for about 30 years after which they’d retire and own their home outright.
The banks wanted nothing to do with such a long long term loan as it ties up capital for nearly a third of a century. You need investors that are willing to buy these loans so that banks can return the capital to the market and lend it again. But investors didn’t want to buy 30 year paper either unless the government guaranteed repayment, which is why we have Fannie Mae and Freddie Mac.
In most other developed countries, borrowers use mortgages with 10 or 15 year terms and likely have a variable rate as well. Turns out the 30-year fixed mortgage is an outlier. Because payment is stretched out over 30 years, you’ll pay a lot more interest than you would with a 15 year mortgage. But Americans – and particularly lawyers – love the certainty of the fixed interest rate and so it remains a popular product.
I don’t buy the flexibility argument (“I’m going to pay it off in 15 years but am taking the 30 year mortgage just in case.”) If your mortgage payment is so high that you value the flexibility of “just in case”, you’re very likely buying more house than you can afford.
Worse, you’re ignoring all the evidence of behavioral economics that strongly suggest you’re more likely to start off making the minimum payments (“because I’m just getting started, my income will go up over time”) and then make a few 15-year payments but drop down to somewhere in between those numbers (“Rough month, unexpected expenses, Christmas is so expensive!”). Eventually you’ll sell the house after 8 years anyway and never think about it again, except that if you did the math you’d realize you that you paid a higher interest rate than you needed to and made substantially smaller payments toward principal than you would have had you just taken out the 15 year mortgage in the first place.
Want to be rich? Take out a 15 year mortgage and pay it off in 10 years.
Stupid debts and lawyers
Of course there’s plenty of other short-term finance charges, unnecessary insurance and warranties and other debt that lawyers take on. But if that’s you, think about who is making money off of what you view as a conservative approach to finances because of a misguided desire to hoard cash? It’s not you. You’re working for the banks! They purchased your car, your house, your iPhone and are letting you use it because you’re their awesome investment.
Don’t be their awesome investment.
Joshua Holt is a practicing private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He is always negotiating better student loan refinancing bonuses for readers of the site or finding honest companies that provide student loan advice for a fair price.
Seven thoughts on Lawyers Working for the Banks
I have to disagree with your take on car loans. I have a zero percent car loan and the same cash in a 3 percent cd of the same term. I’m making two percent a year so it is possible… But…. I didn’t get the car because of zero percent or buy more car to do so. I bought the car intending to pay cash and instead used a loan as the last step. It’s kind of like coupons or discounts. They are good if they are the last step. If they encourage you to pay more then you planned or buy in the first place then they are bad for you. Plan your purchase including how much your willing to spend, then look for deals and arbitradge, not the other way around.
Do you find having the two accounts (car loan and CD) worth the mental energy to make a what I’m guessing is around $600 a year? I assume it’s all automated, but over the past few years I’ve started to really value the simplicity of consolidating as much of my financial accounts as possible.
It’s Managing Partner again!
Question – If I could give you a loan for $500K that you could invest in the stock market (say, SP500 making 9%-ish on average – after taxes maybe 8%) and the actual cost to you would be only 2.4%, would you be interested? 30 year term? That’s about $28K/year-ish if you arbitrage.
Well, if you have enough money to pay 500K cash for a house or to take a mortgage, that’s the decision that you have to make. (I know – only 500K? Yes. Move out of NY and 500K is a pretty decent 3-bedroom, 3-ba. However, if you are paying $1M, the math only becomes more compelling) If you are paying 4% on your mortgage at a 40% combined personal tax rate, then with the tax deduction it is really only costing you about 2.4%.
I think that your advice to pay off the mortgage is good – especially for middle class people who have the bulk of their net worth in their house, or who will fail to keep investing as you manage. However, if you are more disciplined, the arbitrage of taking a mortgage rather than tying up your cash can be an advantage.
Think of it this way – you have 500K that can either be invested in an investment that will deliver an 8%-ish post-tax return (market) or a 2.4% post-tax return (paying cash). Take your pick.
Welcome back Managing Partner! I might take your deal for $500K but probably not. I’m glad you framed it as borrowing money to invest in the market, since that’s essentially what you’re doing when take out a mortgage when you otherwise had assets sitting in a taxable account that you could have used to purchase a house (the big difference being that with the house, you have the asset in the form of the real estate, rather than simply taking out a $500K loan and investing the money in the stock market).
The problem I have with the arbitrage argument is where does it stop? If it’s a great deal to arbitrage $500K, then it follows that you should be arbitraging everything you can get your hands on. Why pay $800 for an iPhone when you get get 0% financing and pay for it over 2 years? Or why buy new appliances when you get 0% financing? The logical conclusion is to borrow as much as possible and invest the rest!
The fault I find in this argument is that humans are subject to all kinds of behavioral problems when it comes to making these types of decisions. If you could let a computer handle the investment such that it really was borrowing $500K and investing it in the stock market (and not touching it or letting it sway your other decisions), then the math clearly shows it to be the better option.
But what are the chances that something comes up and you spend a bit of that money? Or even if you think you wouldn’t touch the $500K, do you think it would influence you knowing you had $500K in a stock market account when it came to spending other money? I believe there are ample chances to makes mistakes (both conscious and subconscious) that make it a lot tougher to justify the $28K in yearly arbitrage.
Ultimately though, it’s a numbers game. Would I take you up on the offer if you let me borrow $1 billion? Absolutely! But I know for sure I wouldn’t do it for $10K. There’s a sweet spot somewhere in the middle and if I had to guess, I’d say it’s north of $500K.
Thanks for reminding me that $500K houses exist. Sheesh. I do need to move out of NYC.
Agreed! It takes serious discipline. You also have to really bifurcate the purchase decision and the financing decision – one decision is which house to buy and the other decision is how to finance it, and you can’t let the tail wag the dog. You are still trying to buy a reasonably-priced house that fits with your saving plan rather than “buy all the house that you can afford”.
You will also probably find it easier to do something like this when you already have a million or two. If the mortgage only represented a portion of your portfolio, it is easier to treat it as an “investment” and the difference in behavioral pressure you will feel will likely be minimal.
In terms of the maximum, only up to 1.1MM can be deducted (1M mortgage and 100K home equity) on your taxes. I also agree that it doesn’t make sense to get fancy at low amounts like 10K. However, if I hypothetically had to pay 1MM to get a reasonable house in NY and my after-tax spread is 5.5% (55K) and my marginal tax rate is 45%, then my decision take a mortgage (just looking at the finance decision here, not the purchase decision) reaps me about as much after tax income yearly as a $100K bonus would- and I would have had to have worked far, far harder for that bonus.
Took out a thirty year mortgage and paid 90% off in less than a year. Can’t decide whether to squeeze a bit more tax deduction out of it or just be done.
We need to get rid of the entire 30 year concept as it artificially inflates housing prices and chains citizens via ongoing debt. I truly think we should limit mortgages to five years and encourage more renting. And don’t get me started on federal student loans causing tuition increases.
The 30-year concept is definitely for the benefit of the banks and maximizing that amount of money the borrower pays to a bank over the course of their working career. I’m afraid if we got rid of the concept we’d see a sharp drop in housing prices though …