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Is debt good or bad for individuals?
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By Stuart Langridge
As individuals around the western world seem to be getting into ever deeper financial water, understanding the nature of personal debt is becoming more important for society.
Without doubt, borrowing money does have positive traits. For example, personal debt has helped to dramatically raise living standards in many western economies. It has enabled many millions to own their own homes, travel the world and start businesses. Seen under such a light, borrowing money has to be a good thing.
The recent experience of low inflation and low interest rates has enabled many people to purchase a property using mostly borrowed money and benefit as the property value rises. These people have seen their mortgage charged interest at around 5% pa, although even less for many, and inflation rates at under 3% pa, whilst their property increases in value by 15% or 20% annually.
These gains are magnified by the borrowed money. A purchaser might only have invested a small amount in the property as a deposit, yet their net worth is increasing relative to the value of the home rather than the value of the deposit. In investment, this is known as leverage. Whilst personal debt adds to the rewards, it can also add to the risks.
Those of us who fear personal debt and have strived to avoid it have been had much cause for regret.
Of course such low interest rates are available partly because a mortgage is arranged as a secured debt. This lowers the risk to a lender substantially. If a borrower defaults on a loan, the lender has the ultimate punishment of repossessing and selling the property.
The personal debt problems faced by so many in society are not generally linked to mortgage borrowing. Admittedly, many people have very large mortgages and are stretched nearly or to the limit of their finances. But, for most people, the loan problems they face are unsecured and the money is spent on the little things in life that add up tremendously but are often insignificant individually.
These are things like clothes, meals, electronic gadgets and more that are generally bought these days with a credit card. Whilst they may offer benefits in themselves, borrowing money to purchase them is fundamentally a bad idea.
The gadgets and toys that improve our lifestyles should really only be bought once we can afford them and have the money rather than before. This purchasing phenomenom has been described as, ‘Taking the waiting out of wanting’.
Purchasing an asset, like a property, with borrowed money that then appreciates in value is often a way of enhancing an individuals finances and situation. However, purchasing the latest stereo or pair of shoes is unlikely to lead to an increase in net worth.
These toys and consumer goods are the tip of an iceberg though. Following finance as I do, I have read a number of reports in the past that describe families whose budget is so stretched that they use their credit card and borrow money to pay for food. As interest rates have started to climb, this is very likely to be a growing occurence.
Ultimately, if you have to borrow money to be able to eat, you have to bowwor money to eat. However, this represents many things. Most probably, this represents an inability to budget household finances carefully or spend incomes sensibly. These are not just problems that relate to personal debt, but life skills issues too.
This represents the other edge of the debt sword. Borrowed money needs to be repaid. Sooner or later, the bills will be become due. Living beyond our means will always lead to ruin, it always has.
Personal debt is essentially a trade off. We trade money now, for our money in the future. For the vast majority of us, that trade means that in the future we will need to spend hours working to maintain interest repayments and eventually repay the loan in full. We are trading money now, for our time in the future. This isn’t slavery, but it isn’t far from it either. We are creating future obligations which we must fulfill.
For your author at least, this puts the latest gadget on a shop shelf and the personal debt needed to purchase it into perspective.
Stuart is an independent international financial and investment consultant who works with expatriates throughout the Benelux region. He also writes extensively about personal finance topics.
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