Debt certainly seems evil, but we give it a poor
rap. If you have ever been totally unable to obtain
credit, you understand how difficult life can
be without debt. I am fond of saying that debt
is like fire - you cook with it, you heat with
it, you relax in front of it. And if you misuse it, you can burn your house
down with it. That still doesn't make fire bad.
There are two different kinds of debt and both
have good uses: Consumer debt, and Capital debt.
Consumer debt is debt on depreciating or consumable
assets. This debt is usually very inefficient
because it violates a financial concept called
"matching." Generally, you are supposed
to match the term of the financing with the life
of the asset being financed. So you can see, for example, that food
can never be properly "matched" with
debt.
Even when debt is properly matched on consumer
assets, as in a car, you have the problem of paying
interest on a depreciating asset. When you purchase
a new car and roll it off the lot the value of
the car loses 25% without even a nick in the paint.
Immediately you begin paying interest on a debt
that is no longer covered by asset value. This
is usually bad but there is an instance were even
inefficient consumer debt has a good purpose.
Consumer debt is good when it allows you to buy
an asset that you cannot afford, but absolutely
need. You see, when you don’t have the cash
to buy a car, consumer debt is a good thing. We
all recognize this at the transaction; we only
begin regretting the debt later when we question
the interest on the debt instead of questioning
the cost of the item.
Capital debt is used to purchase assets that
will appreciate, hold value, or produce an income
stream. Capital debt is always an efficient use
of money when you can afford the payments. Businesses
seldom pay off capital debt. For example, businesses
would rarely take $10 million out of production
to throw it into a dead building in order to avoid the
interest on a simple-interest note. But families,
who do not have nearly as much money as businesses
do, throw their money into their house because
it is supposed to save them money.
Stop thinking of debt as an evil thing. It is
not good to have too much debt, but it is not
good to have no debt either. Balance yourself
between what you can afford and what types of
debts you really need. Above all else, save money. |
