On a macro level, debt was a force behind the incredible economic expansion over the past two centuries, and the availability of debt at the family level played a role as well. Despite all that debt has brought society, many financial gurus and authors vilify debt and explicitly call the idea of borrowing money “evil.” Typical mass-produced financial advice often calls for avoiding debt as much as possible. Is this a realistic goal in economically developed nations in the twenty-first century?
For some, it is. There is no doubt that there are many ways families can survive and thrive while avoiding the need to borrow money at all. Avoidance of all debt can be a struggle for most families, particularly in today’s United States. Are the sacrifices worth the effort?
To join in this discussion, you must accept that debt is not evil. All forms of money are tools to simplify the exchange of goods and services. As tools are objects with no inner consciousness, they can neither be good nor evil, as these words indicate a nature of intentions. Intentions require a sophisticated neural network, something lacking as much in money as it is lacking in a doorknob.
If you’re still with me and you agree that borrowing money is not an evil concept, you might also agree that the tool of debt could possibly be used for both wise and unwise decisions, designed by the active neural networks in human beings (the tool-wielders).
From a pure numerical viewpoint
Even though amounts and values of money are normally symbolized by numbers, money is never solely about digits on a ledger. If it were, there would be only one reason to go into debt: an opportunity to use someone else’s money to earn more money than what is borrowed — a sure thing. If I offered you $10,000 without interest with the only caveat that you repay me slowly each month and in full by the end of twelve months, it would be wise to accept the offer, invest the $10,000 in a safe investment like a high-yield savings account, pay me back, and keep the interest you’ve earned for yourself without much effort.
This is what credit cards have been offering, though less frequently recently, with 0% balance transfer offers, or so they’d like you to believe. If you look deeper, there are usually some risks:
- The credit card companies might drop the promotion.
- If you fail to make a payment in time, even if your check arrives on someone’s desk one minute too late, you will owe interest to the credit card.
- The bank might lower the interest rate you are earning in the savings account to a point where the exercise is not worthwhile.
- Your credit score will decrease due to an increased utilization ratio, forcing you to pay more for new loans or mortgages.
The numbers are trickier when you question whether to take on debt at a higher interest rate with the possibility of earning more from a riskier investment, like stocks. Here you have to weigh the probability of not earning more than the interest you will be charged for borrowing the money.
In the end it is a judgment call. You could devise complex algorithms to help you to decide whether to borrow money at one rate for the possibility of earning a higher return on an investment, but anything can happen.
Debt for education
One of the most prominent rationalizations for accepting debt for education, like student loans, is from the purely mathematical viewpoint. People who go to college earn more throughout their lifetime than people who do not. The numbers show that in many cases, money spent for college, including interest payments lasting ten years after graduation, are worthwhile thanks to increased career opportunities and salaries. On average, an individual with a Bachelor’s degree will earn twice as much as an individual with only a high school diploma, though the statistics will differ depending on the field of study and the career.
Thus, it often makes mathematical sense to enter into debt to obtain a Bachelor’s degree, if necessary. There are ways to avoid education debt, such as having parents who have earned and saved enough money to fully fund the education, choosing a free or less expensive school, obtaining grants or scholarships, or even working. When these options fail, the possibility remains that choosing to attend and graduate from a certain college and accruing debt will be a better decision than not earning the degree at all.
Student loans can generally be found with low interest rates or with a portion of the interest being subsidized by the government because it is in society’s best interest to produce a well-educated workforce and thinkforce.
Your career’s start-up expenses
When a new company is formed with a visionary idea, there are often required start-up expenses. These include finding real estate for an office or storefront, furnishing the office or acquiring inventory, hiring employees and paying them salaries, and spreading the word about the new business. I like to compare this process with a recently-graduated student entering a career. Unless the business has received help from investors (who often require that they become part owners), these start-up companies rely on loans.
Similarly, in some cases new employees can be excused for using debt to put them in a competitive position for starting their careers. Dressing appropriately and presenting a professional appearance requires expenditures for which a newly-minted graduate may not be financially prepared. (This is one reason I suggested the gift of clothing or gift cards for recent graduates.) Attending networking events, sending out resumes and traveling to interviews are all start-up expenses that must be financed in order to land the right job.
That first job is an important indicator of the remainder of your career, particularly if you remain in the same career path your entire life (as fewer people do). The better placed and paid you are in your first job, the higher your income will be throughout your career.
If necessary, a moderate amount of debt at the point you start your career will provide the opportunities to place you in a better position for future earning.
Owning a house
Thanks to the prevalence and availability of debt, consumers have reached higher and higher beyond their means. In the 1960s, median house prices were about 2.5 times the median annual household salary and at the height of the housing market in the early part of this century, the multiple was around 5 (source). Saving to pay for a house with cash could take years or even decades.
During the height of the housing frenzy, many families were willing to take on debt using the above numerical viewpoint. House prices seemed to go up without fail, and the prospect of earning more by leveraging a house purchase with debt seemed to make financial sense. Unfortunately, the underlying assumption that real estate prices always increase proved to be incorrect and many families were hurt due to over-leverage.
But that doesn’t mean that it’s never wise to buy a house with help from a loan. Buying a home should not be a purely financial decision. Families often want to create a stable home environment, and settling down in a location with the intent to stay for several decades is a key component of that idea. Furthermore, families with children want to ensure that the free public education offers a quality experience, and regions known for excellent education, in high demand, will often be more expensive.
A mortgage, while a decades-long debt sentence, is not evil. It makes sense for families to live in the best location they desire if they can afford the debt payments.
When else is debt worthwhile?
If you accept debt into your life, there are sacrifices you will need to make. You will also need to accept other sacrifices if you refuse to enter debt. It comes down to personal choice. Is it crazy to be willing to accept debt, as long as it is affordable and well-purposed? Or do you agree with idea that money is a non-intentioned tool, to be used in whatever situation logically calls for it? Are there any other instances where it can be a smart decision to take on debt?
Published or updated June 10, 2009.