Going Into Debt Can Pay Off--Sometimes
President Bush recently told the nation’s banks and the Federal Reserve that he’d like to see them cut interest rates.
That’s because he’d like to see you and me spend some money. And he knows that with unemployment at a five-year high and personal income growth at a near standstill, we’d probably have to borrow to spend.
Bush wants us to start spending because if we all start spending, the nation’s economy will start to grow, which would be good for the country. But in this case, what is good for America as a whole may not be good for individual Americans.
Over the past decade, Americans have sunk deeply into debt.
Many are now grappling with seemingly impossible monthly payments, and there has been a staggering rise in consumer debt problems and personal bankruptcies. Personal bankruptcies, in fact, are expected to hit an all-time high in 1991.
For overextended individuals, the result can be financial ruin-- the loss of their homes, cars and credit ratings. A bad credit rating can even cost individuals professionally.
Some companies are hesitant to hire or promote those who have been less than responsible with their own finances, industry experts say.
This does not mean, however, that you should never take on debt.
“There are some good reasons for being in debt or for incurring debts today, assuming that you are not over-indebted,” said James Kuttner, academic associate in Advanced Studies at the College for Financial Planning in Denver.
To wit:
* Buy anything that increases your earnings capacity, Kuttner says. If, for example, you need to take out student loans to get a college degree, that’s money well spent.
Spending on continuing education programs or training in a trade can also be a good investment. And that’s true whether or not this additional schooling gets you a raise or a promotion, he said.
“Especially now with the recession, people need to adapt. You may need additional training just to maintain your current position,” Kuttner added. “The fact that you are able to stay current with skills and technologies beats the heck out of seeing the world pass you by. It would be a justifiable reason to incur debt any day of the week.”
* Borrow to buy things that will help you reduce current and future monthly expenses. Examples range from more efficient office equipment, to solar energy panels, to a new car.
If, for example, you replace a gas-guzzling clunker with a newer model car, you could reduce both gasoline and repair expenses. Perhaps that also makes you a more dependable employee: You no longer arrive late because of car problems. If something saves you money in the end, it probably makes sense.
But beware of spending too much for something that does not generate substantial savings.
If you spend $100 on an item that only saves you $1 each month, it will take more than eight years for that investment to pencil out. By then your purchase might be worn out and in need of replacement.
* Borrow when you could earn more investing the funds than you pay in interest. Such investment opportunities are relatively rare but they do occasionally come along.
And now, with the economy depressed, there may be selected opportunities to buy.
If, for example, you can buy a piece of real estate at a bargain price simply because the seller is distressed, it might make sense. But then, you have to be careful fully to consider the cost and likely return on your investment.
Be wary of “projected,” “anticipated” or “estimated” returns. These are a far cry from a sure thing.
* It may also make sense to borrow money to start a new business or to relocate to take a job, Kuttner said.
Each opportunity must be weighed carefully with an eye to the potential opportunities versus what will be risked or lost.
On the other hand, you should not borrow to meet monthly living expenses. Do not borrow when you’re already having trouble paying your debts. And you generally should not borrow when you could just as easily pay cash.
Indeed, it is generally foolish to have both debt and savings--even if the savings is your “emergency fund.” Typically, you earn less on your savings than you pay on your debt.
Consider, for example, someone with $1,000 in a 5% passbook account who has a borrowed $1,000 on an 18% credit card. This person would pay $180 annually in interest charges on the credit card and earn only $50 on their savings. By paying off debt with their savings, this consumer would be $130 richer at the end of the year.
And, in emergency, he could tap his credit line almost as easily as his savings.
