If the world runs on credit why do I need to stay out of debt?

It’s ok to borrow five times more than you own for a house, most folks say. We got into trouble when people borrowed the entire value of the house.

I’ve heard it argued that you can apply the same rule for investments. Borrow two to three times as much as the value of your investments.

In boom times, this works well, and you make tons of money. Of course, if you don’t get out in time for the crash, then you are in wrist-slitting territory.

We borrowed to buy our house, and put 20% down. A few more months, and it’ll be ours. We’ve never leveraged our investments, so, although we’ve lost 35% of the value, like everyone else, at least we aren’t in trouble because of it.

Credit card debt, though, is the worst. You’ll never be able to save anything if you don’t pay off in full every months. That’s because you pay 18% interest, and if you only pay the minimum, the amount you owe will grow and grow. That $100 gadget will end up costing you $500.

Better not to spend, but to save as much as you can. There are good debts and bad debts. A debt that helps you earn is good (like houses and investments). A bad debt leads to nothing (credit card debt) because you consume what you buy, and there’s nothing left after it’s gone, but the money you owe on it.

As long as you’re in debt, you’ll be paying interest on it. This means you’re flushing money down the toilet. Of course, this money does benefit some people, namely the bank employees who get paid, and all the people who sell things to them, but you can benefit the economy just as well by spending that money yourself rather than giving it to the bank for free.

In other words, why screw yourself, just to stay in debt?

It’s not that if no one had debt, the economy would crumble – it’s that if no one were able to get credit, bad things would happen. We’re seeing it.

Being in debt is okay as long as you’re putting that money towards something that has a higher return than the interest you’re losing on that debt.

For instance, if you take out a loan at 5% to pay for a house, it’s only acceptable if your house is earning money faster than 5%. If you’re losing money on the project AFTER the interest, then it’s not okay. Eventually, you will bankrupt yourself at that rate.

Personally, I had some money in investments that I’m now pulling out of the market to pay off my school loans. Those investments have a worse return than the interest on the loans, so even though I’ve been paying back those loans for 7 years, only now is it a bad idea to keep that debt. Say the interest on the loans is 4%. If that money is making 6% in the stock market, then I end up with a 2% gain, when all’s said and done. By keeping that debt, my net worth increases.

Economies like debt because, presumably, someone will take out a loan for a project that will generate much more money than it cost to create. Lots of people don’t have the capital to undertake those projects by themselves, so without the possibility of debts, nothing would get created. Debt and loans are an extremely important part of an economy.

In closing, you don’t need to stay out of debt if you’re going to use that money towards making MORE money. If you’re just going to be buying a new television, that’s not an investment (since it will never make money for you) and, therefore, a bad reason to go into debt.

PS. this is why increasing the national debt to continue to wage war in Iraq is insane—it’s not an investment and will never generate income for the country. Our grand childrens’ tax dollars are being burned for something that will never pay for itself.

What about consumer debt? I’m not talking credit cards, I’m concerned about my car loan. My new car debt and my student loans is the only debt I have. The loan I got doesn’t have a fee for early pay-off, so maybe I should pay more than the minimum each month.

If the car is going to yield more money than not having one, then it makes sense to take the debt. If you’ll have more money at the end of the year by not having it, then it makes sense to give it up.

Just think about what you’d be doing with the money otherwise. If you can’t think of a way to get a better return with the money you’d use to pay off the debt, than the interest from that loan, then you should pay it off.

If you’re going to invest in a home business that will end up earning more money than the interest on your loan, then you should use that money to pay for that instead.

It’s okay to use credit, providing you have cash in the bank to pay off credit cards. Credit is a convenience. You should not borrow money to buy a car. A car is a depreciable asset. It decreases in value the moment you acquire it, and you are paying interest on the loan you take out to purchase it. It never hurts to pay a little extra on debts, but you also need to be saving to insure that you have enough money in the bank to cover your rent, car payment, and other bills for a least 6 months, in the event that you lose your job.

Pretty much every person I know has a car loan payment. Cars are not really affordable otherwise.

Debt is a leash, and it’s great when it’s a long leash. Right now it’s a short leash. You don’t have control over the leash or when it becomes long or short. As long as you “live beneath your slack in the leash,” I suppose it’s no biggie.

Also, we have ridiculously low interest rates in the U.S. compared to many other countries. Let’s hope it stays that way.

These days it’s a good question.
What is the problem with a person incurring debt if he can reasonably expect a taxpayer someplace else to pay it back?