Watching TV, and even surfing the net, or just going from website to website, you get adds from Banks and Loan companies trying to get you to borrow money. There is a famous line from Shakespeare’s Hamlet that most people know. “Neither a borrower nor a lender be: For loan oft loses both itself and friend; and borrowing dulls the edge of husbandry”. William Shakespeare was known for writing truth in his plays. Truths’ that are often as valid today as they were then.
Many things in life have changed since William Shakespeare’s time. Today Banks and Loan companies push you to borrow as much as you possibly can. Fifty-six per cent of bank revenue earned is net interest income. This comes from The Canadian Bankers Association website posted September 24 2018. WOW! No wonder they want you to borrow as much as you can! The percentage for Pay Day and other loan companies approaches 90%, because they don’t offer other services they can charge for, like banks. No wonder DEBT is such a concern (problem).
Even though banks love you to borrow, they do not lend for every purchase. I asked my bank if they would lend me $20,000.00 to buy their bank stock? The answer was a swift and firm NO! But they would let me borrow $20,000.00 to put into their mutual funds. Isn’t that surprising. There will be another post about why that works.
But is all debt BAD?? If you listen to one bunch of money gurus, the answer is YES! Don’t buy anything unless you have the cash for it. That includes houses and cars. But if you ask real millionaires, if all debt is bad, the answer is NO! If all debt is bad, then why would banks want you to borrow money. In the Wealth Accumulation course, we talk about GOOD and BAD Debt. We talk about the difference. Because, Wealth Accumulation uses GOOD Debt to create WEALTH while BAD DEBT only creates misery. Bad debt is just BAD! So what is the difference. (Banks are sources of GOOD DEBT, but also heavily promote BAD DEBT.)
Bad Debt gives you no financial return. Good debt does give you a financial return. It is that simple. The financial return does not always have to be only interest, but that is most common.
There are hundreds of illustrations of BAD DEBT. One of the most common is a credit card. But even they are not as bad as a Pay Day loan company. Neither of these give you a FINANCIAL gain. Yes, a credit card will let you buy something, even if you don’t have the cash, but that thing your buying, is probably not going to make you any income. BAD DEBT buys Expenses and Liabilities.
GOOD DEBT is a debt that supplies enough income to cover it’s own costs, and maybe even makes you a little (hopefully a lot) of extra income as well. Either immediately, or over time. GOOD DEBT buys ASSETS.
Let us look at a GOOD DEBT scenario. You want to buy a 4 plex, and live in one of the units. Most normal people do not have the cash to buy a 4 plex outright. So, you need to borrow some money in the form of a mortgage. A mortgage is DEBT. No argument there. But this Debt, will give you a place to live, and the income from the other 3 units will pay the mortgage, expenses, and leave you with an extra $100.00 a month to boot. That is good debt. It might even make enough to allow you to pay either a reduced rent, or maybe even no rent at all. (Put the rent you save away, and use that money as the down payment on the next 4 plex.)
Another cheaper example would be borrowing $2,000.00 to buy a mutual fund in your RRSP. Yes, you will have to make the loan payments over the year, an expense, but it might get you a tax refund (Which should go into your RRSP as well) and by the end of the year, you will own the mutual fund units, and they might have gone up in value. The interest cost is also tax deductible. (So my accountant says.) If you are not good at saving, this might be a good way to get ahead using a small Good Debt.
Buying new shoes with a credit card because they are on SALE 20% off, is not a Good Debt. For one thing, did you get the 20% savings handed to you as cash??? Can you realistically sell the shoes a year later for more money? (You’re not a sports star)
GOOD and BAD debt, are based on what you FINANCIALLY get out of the purchase. NOT THE EMOTION!!! Debt is about money. The normal emotions that accompany BAD DEBT are fear, hopelessness, stress, low self esteem, desperation. The emotions that come from GOOD DEBT, are satisfaction, security, high self esteem, empowerment.
Is all DEBT the same?? Heck no!
Just a note: It is very tough to live today without a credit card. Credit cards are like fire. Under controlled circumstances fire will heat your home and cook your meals. When it gets out of hand, fire can destroy whole communities. If you have a credit card, have only one, and pay off everything but $50.00 every month. If you never carry a balance your credit score will suffer. That’s the topic for another post.