If you ask a regular personal finance adviser whether you should borrow money, they will give you the Debt Creed;
Only borrow to invest, if the investment will earn you better returns than the interest rate of the borrowing. Never borrow for consumption. Aspire to be debt free at all times!
However, life does not work so neatly. Most of us have borrowed money which we invested and lost, we have borrowed for consumption, we have borrowed for stuff like cars and we are still unsure if it was an investment or we poured money down the drain, we have borrowed for the frivolous too.
I believe in practical life advice and therefore I do not advise people to never borrow money. I say, you should always borrow smart. A smart borrower starts with the fundamental and most important question:
“Can I comfortably repay the loan?”
Can you repay the loan with your current income, without compromising your 10% basic saving and investing plan? If the loan will take up your entire surplus including this amount which we should save always, then you are probably not being very smart about borrowing.
If the answer is yes, then the other qualitative questions come in:
What are you borrowing for?
- A want – Only borrow if the repayment will not compromise any part of your savings and investment plan. If you can repay it comfortably out of your surplus, or can cut expenses to make room for the loan repayment, then borrow. If you have to dip into your savings, then it is not worth it.
- A need – Borrowing for a need is tricky, because you really do not have much of a choice. My advice here is that you need to put in place a plan to make sure you do not make this kind of borrowing your default for dealing with life obligations. Start setting aside small amounts for your emergency fund, and when you are done repaying the borrowing, increase the money you set aside. Also, if you find yourself needing to borrow to sustain your lifestyle, consider scaling down your daily expenses. Move to a cheaper house, move the kids to a cheaper school, etc. Live within your means.
- An investment – The basic rule applies, but sometimes we borrow to invest in things that will only pay back in the long term (e.g my farming land). First thing, be clear on whether you are investing or speculating, since the loan repayment will take away money you would be saving and investing in other avenues. If the investment fails, you have wasted time, wasted your savings and paid interest on those savings. So before borrowing to invest, have the right information, and a back-up plan.
In conclusion, while I admire people who live totally debt free lives, I do not think borrowing is the path to financial destruction. Debt is a personal finance tool, how you manage it is what makes it positive or negative.