While debt is one of the means of meeting financial needs, it definitely is not the only way but it is one often misused. Debt enables you to enjoy a purchase now as you pay for it later. Debt creates an illusion of prosperity to both the borrower and observer due to the visible display of riches such as grand homes, cars and expensive clothes while all these might be financed through debt. The true measure of wealth is the net worth, determined by deducting liabilities from the value of assets resulting in a positive or negative net worth. Assets are things of value that you own while liabilities are money you owe to others.
This principle is applied concurrently with the other four principles since they are interconnected. In previous articles, we looked at the principles of spending less than you earn and building liquidity and we are yet to look at having a long-term perspective and giving generously. We have established the importance of having a clear vision and a thought out detailed financial plan. When complemented with delayed gratification, the obvious result is minimal or total elimination of debt.
Let me share my top three reasons for avoiding use of debt in my personal finances.
First, the high cost of debt comes in in varied forms that include:
- Economical cost in terms of interest expense which increases the cost of a purchase without increasing its value or in some cases loss of an asset used as collateral if unable to pay off the debt
- Psychological cost in the form of mental burden and stress
- Relational cost as evidenced in strained marital and family relationships especially when the decision to borrow was not mutually agreed upon
- Opportunity cost in lost opportunities that were never taken due to unavailability of funds as they were tied to debt repayment
Secondly, every debt has an effect of reducing net worth by increasing liabilities while the purchase does not necessarily increase value of assets until the debt is fully paid.
Finally, debt repayment mortgages the future by diminishing both future flexibility with finances and standard of living as future income goes into debt repayment instead of enhancing lifestyle.
Is there anything like good debt?
With exception of emergencies that exceed the value of an emergency fund, most common uses of debt such as shopping and school fees can be avoided with proper planning. A good debt meets all the following four requirements:
- The economic cost of debt is lower than the economic benefit
- There is a guaranteed way of repaying the loan
- Where applicable, there is harmony among spouses concerning the debt decision
- There is no other way of meeting the need
A mortgage is one of the few uses of debt that might meet the above criteria, however even then, it is prudent to accelerate repayment to save on interest expense and get out of debt.
Scriptures are awash with caution against use of debt as well as encouragement to trust in God for all provision both now and in future.
- Psalms 37:25 (NLT): Once I was young, and now I am old. Yet I have never seen the godly abandoned or their children begging for bread.
- Philippians 4:12-13 (NLT): I know how to live on almost nothing or with everything. I have learned the secret of living in every situation, whether it is with a full stomach or empty, with plenty or little. For I can do everything through Christ, who gives me strength.
- Psalms 60:12 (NLT): With God’s help we will do mighty things, for he will trample down our foes.
- Romans 13:8 (NLT): Owe nothing to anyone—except for your obligation to love one another. If you love your neighbor, you will fulfill the requirements of God’s law.
- Proverbs 21:5 (GNT): Plan carefully and you will have plenty; if you act too quickly, you will never have enough.
In our next article, we will look at the fourth principle of setting long-term goals or having a long-term perspective to personal finances.