Is Debt Good or Bad?

What are we to believe? Is debt good or bad? On one extreme are some financial pundits that say to go into debt and use other people’s money to make money, and on the other extreme are experts that believe that any form of debt is bad. Who should we listen to?

Ignoring the rare exceptions, most successful people have incurred some form of debt either personally or through their business, and if they did not incur this debt then they would most likely not be in the position that they are in currently, even if they have now paid off all of their debts. Let’s look at some pros and cons.

Pros of debts: Without incurring debts, virtually no one in this expensive area would be able to purchase a house. If you were debt averse and had to save up for your house to pay cash, then you may never get there. If a $500,000 house appreciates by 3% per year on average (let’s ignore significant ups and downs to keep the point simple), then just one year later you would need to save an additional $15,000 to purchase your home. You may never get there.

If you want to expand your business or start a new one and need capital to build out your office or purchase equipment, then a loan is most likely needed. Even the best savers have a hard time saving up the significant sum that is needed to do so. The same applies to investment properties.

Unfortunately, you most likely need to incur some debt to finance college or purchase a vehicle.

Cons of debt: Debt is not without risk and I am a big proponent of proceeding cautiously and wisely when incurring debt. Here are several pitfalls of debt:

Over leveraged: If you incur too much debt than you may not able to meet your payment obligations. This is especially true if and when there is a slow down in the economy and/or your business. Think of debt payments as taking from your future income, but you really never know what your future income will be. If you find yourself with tons of debt then you need to closely examine your spending and look for ways to increase your income.

Increases risk: Debt amplifies the risk of any financial endeavor due to a decrease in cash flow from making debt payments and the financial obligation of the debt. Most debt is personally guaranteed, even if it is for business. Trust me when I say that a bank owns you when you take out an SBA loan. They may even put a lien on your children, but that may just be a rumor.

Makes you spend more (much more): Surprisingly, this isn’t mentioned too often as most people only consider the monthly payments, interest rate, and length of a loan. However, debt makes you less cautious when spending and investing money, even if it is for something productive, such as  purchasing equipment for your business or buying rental properties. The end result is that you wind up spending more than you anticipated. Why do you think so many companies offer enticing payment plans for just about everything? If you have the resources to pay cash, then it probably makes sense to do so.

Increases costs: Even loans with low interest rates increase your costs due to both interest and fees, which can be very significant.

As you progress on your financial journey, then a noble goal is to become debt free. Ideally, you should try to avoid debt when possible, but it may provide you with a much needed boost to get you started. Just do not over do it.

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