Why debt is not always a bad idea
Often we are admonished against borrowing and ballooning our debt levels since debt is viewed as a bad idea especially for the middle and low income earners. The reasons for such kind of precaution are obvious since with high debt levels you will find yourself trapped in the rat race. This is a situation whereby you earn your monthly income to repay debts with all of it; and then borrow more money to spend in the next month and wait for end month again to earn and repay the new debt. As this cycle continues, you find yourself trapped in employment since you need the regular income to repay the debts, yet your income is not resulting to any significant economic development for yourself and your family.
The most common form of debt that traps most people in the US is the credit card debt. According to the NerdWallet Report, an average US household has about USD 16,000 in credit card debts as of December 2016. This figure almost hits the highest level experienced back in 2008. When mortgage loans are added to the credit card loans, the average household debt in the US stood at about USD 133,000 in 2016; up from about USD 88,000 in 2002. The situation is worsened by the fact that income level s are not growing at the same pace as the debt levels; creating a worrisome scenario whereby many households are prone to being bankrupt if the excessive borrowing is not contained.
In the past 13 years, average household income has grown by about 28%, while the cost of living for a typical US household has gone up by about 30%. Specifically, medical expenses jumped up by about 57% since 2003, housing costs went up by about 32% and the cost of food shot up by about 36%. With the unmatched growth between income levels and cost of living, US citizens are left with the option of using their credit cards to fill in the gap in order to access the basics of life and a little bit of luxury. Having the current average interest rate on credit cards standing at about 18.76%, the increased use of credit cards leaves a typical US household with an additional credit card loan interest bill of about USD 1,292 per year. This additional cost can get out of hand if not well monitored; hence the need for you to check your credit card report regularly in order to know how much you are spending on credit card loans and take corrective measures.
When debt is a good idea
Besides the ugly side of the credit card debt, not all debt is bad though. The wealthy understand the term leverage and how to use it in their wealth creation strategies each day. Essentially, what the term leverage means to a financially prudent individual is that you make use of other people’s money to create wealth. This comes in form of borrowing loans from commercial banks where an average citizen has saved their money and using the loan to fund your investment projects. You then repay back the loan after you have already made much more money through the investment you made using the borrowed funds. The whole process is a well thought out venture where the risks have been calculated and the returns have been accurately projected to be way above the cost of acquiring the loan.
The above example is more inclined to a business minded person and not very important to a person who prefers to be employed and earn a regular income. However, for such a person too, debt can be a good investment; in this case getting a student loan to advance your education with the hope of getting a better job with a higher salary. If your education plan is well strategized, getting the student loan is positive thing since it will in the end result to a higher income which hopefully translates to higher living standards in the long run. The returns from the student loan are therefore higher than the cost incurred in when repaying the loan, hence making the student loan a good idea.
A mortgage can also be a good loan if the interest rate is affordable. There are two ways you can choose to pay for your house; one is through a mortgage and second you can choose to buy it cash. If you choose to buy it cash then you will have to save for a long period of time before you can raise enough money to buy the house. In the meantime, you shall be paying rent on a monthly basis on a house that you will not eventually own. Alternatively, you can choose to pay monthly mortgage equivalent to your current rent for a house that you will eventually own after several years. The money you shall be saving can then be utilized in other investments to continue growing your wealth over the years. By the time you finish paying your mortgage, your savings and investments will have grown tremendously to support your decent and comfortable lifestyle with minimal or no debt repayments thereafter.
Depending on how you look at it, debt can be a good or a bad idea. But for you to make debt a good idea, utilize it in an investment that will produce higher returns in the long-run compared to the cost of acquiring the debt.