Debt is borrowing money from someone and promising to pay it back at some future date or over time. Businesses borrow money all the time to expand, provide more services etc. For individuals concerned about their personal financial situation, we need to be more careful.
When individuals borrow money, they need to recognize that the organization lending the money is not lending money for their health. Lenders are trying to make a profit and they do this by charging the borrower interest. The higher the risk of not getting their money back, the higher the interest rate will be.
In an ideal world, you would have all the money you need to do all the things you want without having to borrow from anyone. I don’t know many people that have lived in that ideal world.
My “Golden Rules” for debt:
1. Don’t borrow money to buy something that could be worth less than what you owe on it. i.e. Borrowing $50k to buy a brand new car that will be worth $35k when you drive it off the lot is a bad idea.
2. The faster you can get out of debt the better.
Personal (non-business) debt can be looked at as consumer debt and non-consumer debt. Consumer debt is money borrowed to fund “consumption” like credit cards, car loans and unsecured debt. Debts used to create value, wealth and opportunity are considered non-consumer debt.
Consumer debt is bad and should be avoided. Any time you use consumer debt, you are on the road to breaking the first of my “golden rules.”
Using debt to buy a home is non-consumer debt and the “least bad” way to use debt. Student loan debt is the second “least bad debt. There are guidelines for both of these to help you use them wisely.
Home Loans (Mortgages)
A 20% down payment on a 15 year fixed interest rate loan is ideal. If you must stretch your note to a 20 or 30 year note these are acceptable. If you cannot save up enough to put down a 20% down payment, you should really consider if your financial situation is stable enough to warrant you buying a home or the particular home you are considering. There is nothing wrong with starting out a little smaller.
I am aware there are different loan programs that will allow a borrower to buy a house with a smaller down payment than 20%. Just because the programs exist do not necessarily make them a good idea. Some of these programs come with “strings” attached that can make them extremely expensive over time. Additionally, over extending yourself by purchasing more of a house than you can afford can put you in a bad financial position.
As a final suggestion regarding home loans, be very cautious of variable rate loans or adjustable rate mortgages (ARM’s). They might seem like a great idea in the short term, but buying a house is a long term decision.
Student loans
This area of finance can have a great deal of emotion attached to it. There are several concepts in the process of paying educational expenses I encourage you to consider. I will be writing more about this in a separate article, so look forward to that. For now, here are the key points:
1) If you are making an investment in yourself/your child, the first priority is to make sure it is going to be a good investment.
2) Try to find ways to make that investment at a lower cost (possibly avoiding student debt entirely.)
Don’t be afraid of student loans. In my opinion, the majority of the troubles people are having are due to lack of education and underwriting.
The government has provided an essentially open funding source for educational expenses, and accordingly, the costs in many areas have sky rocketed. Just because the government will give you a loan, does not mean you should spend the money.
If you asked a bank to lend you $50,000 so you could buy a car worth $5,000 a bank would tell you “no.” Unfortunately, this lack of underwriting is a significant factor in the challenges many people are facing around student loans these days.
And this has wrapped up the last of our Four Foundations For Financial Fitness.
1) Spend less than what you earn (and do something intelligent with what is left).
2) Protect what you cannot afford to lose.
3) Build wealth systematically.
4) Use debt wisely.
While these four foundations do not guarantee tremendous wealth, they will get you headed in the in the right direction.
Thank you for investing your time with me and reading these articles. I hope you have found them valuable.
If you are a client, you will soon have access to a client education portal through my website that will help provide a great deal of education about personal finance and the options available, how the student loan process works etc. If you are not a client yet, but curious about these topics, let’s start a conversation here. If you have questions on how to access the client education portal, please let me know.
As I mentioned, my next article will be about navigating the Labyrinth of Student Loans. After that, I will be shifting to more of an open format with random topics based on questions asked of me and I will try to share some information I think will be valuable.
I hope you have found this article valuable and I look forward to your thoughts and feedback via Facebook or email. Please let me know what you think and if there is anything specific you would like me to address. I have gotten lots of great questions and have several topics for future posts, but I want to make sure this is valuable for you. Please let me know what you would like to learn more about.
*I am not recommending anyone buy or sell anything specific, nor am I recommending any specific suggestions. Everyone should discuss their individual situation with their own financial planner and develop a plan they feel comfortable with. Please talk with your financial planner to obtain specific financial planning advice. There are risks involved with everything. Do not invest in anything you do not understand. Refer to investment prospectus’ etc. for details on specific investments.