Many financial experts are firmly convinced that “Debit is evil! Bandwagon – and with good reason in some cases. There are countless stories of bad luck from people struggling to repay large or growing debt.
But some of these advisers can be a little short-sighted when it comes to debt. Fortunately, for every anti-debt extremist, there is another financial expert who understands that debt isn’t inherently bad.
As with most things in life, the truth behind debt is grayer than it is in black and white. And there are a number of cases where debt can in fact be a good thing. Here is what they are.
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When the alternative is worse
The main reason most of us go into debt is because the alternative makes the potential inconvenience worth the risk. If going into debt is the only way to get certain necessities, then it may be worth it.
For example, if your choices are to take out an auto loan or lose your job because you can’t get around, then that auto loan debt makes sense. Sure, it’s going to cost you money in the long run – the interest charges add up, even on low-interest loans – but it’s worth it for the ability to get where you want to go. have to go and keep your job.
However, the key here is to assess whether you are considering a loan for something you want or something you need. Going into debt to get essential transportation is probably smart, while you probably don’t have to go into debt to upgrade your entertainment system.
When the interest rate is negligible
Another time when going into debt can be a smart move is when that debt doesn’t actually have a high cost – or any – cost. That’s because it’s usually not the debt itself that’s the problem (i.e. the original amount you borrowed). No, in most cases, it’s the interest charges that make debt difficult to repay.
However, if you can avoid these expensive interest charges, then debt often becomes much more manageable. The most common way to avoid interest on debt is to use credit cards with 0% APR offers. These credit card consolidation have introductory or short term promotions where you pay no interest for a set period of time.
When you make purchases on a card with an active 0% APR offer, you can carry a balance from month to month without accumulating interest charges. While you should always make at least your required minimum payment on time each month, these offers can give you six months or more to pay off your purchase without worrying about interest charges.
When the opportunity cost makes sense
A commonly used method of making financial decisions is to look at the opportunity cost. Basically, opportunity cost describes the opportunities you give up when you use your money for something else. For example, when you walk into a store with $ 20, if you spend that $ 20 on a few magazines, you forgo the option of spending that money on a bottle of wine and a frozen pizza.
When it comes to getting a loan, sometimes it makes more sense to go into debt – even with interest included – than to use cash for the purchase because of the opportunity cost. This can be especially true when it comes to large purchases.
If you have $ 200,000 in cash, for example, you can use it to buy a house. You would have no mortgage or debt. This is the path some anti-debt experts would suggest.
However, there is another option. Instead of using the money to buy your house, you could take out a mortgage and then invest your money in the stock market. The average mortgage has an interest rate of around 3% at the time of writing. The stock market has an average return of around 7% (over 50 years). If you invest your money instead of using it to buy a home, you could earn more on that investment than you save by avoiding a mortgage.
When it’s an investment in your future
In some cases, getting into debt is less about the debt itself; it’s more about making an investment in your future. For example, as long as you have a solid business idea, a business loan may be a reasonable investment. A smart entrepreneur can turn a small business loan into a booming business that not only pays off the loan, but provides years of income to get started.
Of course, there are many situations in which going into debt is not the best option. If you are living beyond your means, then going into debt can put you in a serious financial crisis. But to call all debt evil is an oversimplification. When used wisely, debt can be a great tool for improving your personal finances and your life in general.