Comedian Bob Hope once quipped, “A bank is a place that will lend you money if you can prove you don’t need it.”
We chuckle, but it’s true.
Lending institutions couldn’t stay in business long if they loaned money to folks who couldn’t repay them (with interest).
So banks are careful. They consider the risks before issuing a loan. We should do likewise before taking their money and going into debt.
When is debt constructive? When is it destructive? A brief examination of three popular approaches to debt can help us know the difference.
1. Debt instead of discipline. Debt is destructive when it is used because forethought, planning, and self-discipline were not.
Some people seem to believe credit cards possess a magical capacity to create wealth at the point of purchase. Quite the opposite actually. Once you start “revolving” credit on your card, every purchase you make increases in price due to the interest you’re paying. So those shoes costing $200 actually cost you $236 if you’re using a credit card that charges 18% interest.
People who live like this soon find themselves in a modern-day debtors’ prison. Their cards are maxed out but they’re still paying hundreds each month just to maintain their minimum payments.
It’s a painful existence.
Debt is simply a magnifying tool. It makes bad financial decisions worse and good financial decisions better.
Here’s a second approach to borrowing money:
2. Debt instead of delay. Years ago I met a man who had been listening to a Christian financial guru who argued that any and all debt was a sin against God.
As a result, the man refused to take out a mortgage to buy a house. He would only purchase a home when he could pay cash. Consequently, he moved his family into a run-down rental property in a not-so-great neighborhood. It was the only place he could find a house large enough to accommodate his family.
What this man failed to realize is that what he saved in interest he lost in time. You only get to raise your family once. Constructive use of debt would have allowed him to raise his family in a better setting.
Using debt to buy a home can be a very wise thing. Especially during times like these when lenders are “selling money” at all time lows.
Here’s a third popular approach to debt:
3. Debt instead of diversion. I’ve had clients with enough assets to pay off their mortgages. Doing this would have made them debt-free. Sounds like a no-brainer, right?
But they also had the opportunity to buy into the business where they worked. They understood the business and saw its bright future. There was a good chance any money they put into the business would double in the next five years.
Some in this situation would decide to be debt-free and be done with it. That’s a good choice for them.
My clients chose to keep their mortgage payments and invest their available cash in their business. Nothing is risk free, but they didn’t want to “divert” dollars away from their highest growth potential.
Keeping some debt so they could invest instead—debt instead of diversion—was their best choice.
Debt is simply a magnifying tool. It makes bad financial decisions worse and good financial decisions better.
I have a chapter on debt in my book “How to Put Your Money Worries In Your Rear View Mirror – The Financial Freedom Roadmap.” I’ll be glad to get you a free copy if you’ll email at bmoore@argentadvisors.com and ask for one.
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