How To Go Into Debt

In our debt-ridden, credit card happy society, it is easy to get frustrated and want to swear off all forms of debt. You may personally know the horrors of running up a credit card bill and its toxic effect on your life. Inheriting some of the frugalness of our grandparents' generation seems in order.

However, the real skill to learn is not how to avoid debt--It is how to go into debt properly. I'm starting to think that this is an area where people make mistakes on both extremes--some people buy bubblegum on credit. Other people refuse to take out a loan for almost any reason.

When you take out a loan, you do pay interest. You are going to pay back more money than you borrowed. That is the harsh reality that makes many people avoid borrowing at all. However, you have to look at the whole picture. You probably won't mind paying that money back if you took the money you borrowed and used it to make more for yourself.

Sometimes the Hare Beats the Tortoise

For example, let's say two people want to start a business, but each needs cash on hand in order to do so. Person A works 2 minimum-wage jobs around the clock, scrimping and saving over the course of 10 years before he finally has enough money to invest in a business. Person B takes out a loan and starts the business immediately. Person B is paying back interest on the loan, but that person is also fully engaged in his new business making money hand over fist. When its all said and done, Person B is way more ahead financially than Person A, who waited until he had all the money saved up before investing in a business. Plus, Person B is also living his dream 10 years sooner than Person A.

The same is true when it comes to buying a house or financing your education.

It makes sense to borrow money if you can link that to some kind of investment in your life--a capital improvement. This will be something that ends up bringing in more money to cover the interest and then some.

The Multiplication of Tomatoes

You loan me 10 tomatoes today on the condition that I pay you 12 tomatoes later. If I am hungry and just eat the tomatoes, I'm in real trouble. I am full now but still have to feed myself tomorrow AND still somehow manage to pay you 12 tomatoes for the 10 I ate. But let's say I saved the seeds from the tomatoes. I manage to grow 100 tomato plants to yield thousands of tomatoes. It takes virtually no effort to pay you all 12 tomatoes back when I am literally swimming in thousands of tomatoes. However, I would never have had a tomato garden if you did not lend me those 10 tomatoes to start with.

You should never borrow money to pay for living expenses. If you are, then you are not managing your money properly. That's like the guy who ate all the tomatoes and ended up even worse than he was before--still hungry but now in debt. If you don't have enough money to pay for your living expenses now, what makes you think you will have enough to pay for living expenses in the future AND have some left over to pay back the money you originally borrowed? You may be living larger than your income allows. The problem is that when you start paying that money back (and you will), you will be living smaller than what your income would normally allow.

I appreciate that it is a noble feat to earn what you have in life and never borrow in addition to that. I respect that. We need a little more of that in our society which wants immediate gratification and doesn't understand the discipline of working toward a goal. However, society would still be (literally) in the medieval times if it were not for widespread and legal money lending. That one change in society sparked more economic growth than most people realize (it was once condemned by the Catholic Church for Christians to charge interest to each other, which had a negative effect on the economy and spurned all sorts of responses, such as black market "loan shark" type arrangements and just a general lack of money lending).

There is also a nobility in borrowing money, depending on how it is played out. You are asking someone for money that you can't possibly pay back and agree to not only pay it back but also interest on top of that. It’s very gutsy! It can be a healthy and noble risk.

The Cost of What You Didn't Do

You also should consider the opportunity cost of any decision. An opportunity cost measures what you could have had if you made a different decision. Even if you did something profitable, it could still have an opportunity cost because you could have done something more profitable.

Let's say you bought a house for $120K, fixed it up for $10K and now want to sell it for $150K. However, the market is tight. You get an offer for $140K, but that's not really what you want to get for it. You want to make sure you get every penny out of it that you can. You feel it’s an insult to get one penny less, and you are going to dig your heels in and wait it out. So you sit on it for another 6 months, then 9 months, then 12 months before you are able to find a buyer. You finally sell it for $145K and you consider it a victory. You still got less than you originally wanted, but you got more than what that first person was offering 12 months ago. You are happy and feel like you've beaten the system. You waited 'em out and won.

This might make sense if you are a one-home owner and aren't in a hurry. But if you are looking to make sensible investments, you probably lost out. You sat on a piece of property for 12 months to gain yourself only an extra $5K more than the original offer. You could have sold that house at $140K and made a modest profit, then turned around and used that money to buy another house and made another modest profit, and maybe repeated that process 3-4 times that year. You could have made $10K on each house yielding $40K rather than keeping one house and holding on to it and selling it for top dollar.

You profited $15 grand on the whole deal (not counting the 12 months of mortgage payments you made which probably voided all your profits). You had the opportunity to make $40 grand. Yeah, you profited, but the option you did not select would have gotten you far more. The opportunity cost is negative $25 grand.

This is why businesses are willing to put items on sale to get rid of them quickly. The business may actually be losing money to offload those items like that, but if they aren't moving then that shelf space could have held something that sells much faster. It is actually a loss to keep it on the shelves and hold out for a higher price.

Money Isn't Everything

It goes without saying that money isn't the total measure of anything. I have chosen to incur debt and barely subsisted in lower-paying jobs in order to work towards a dream. I chose to struggle financially to build my resume. For example, I wanted to work in the non-profit world, but jobs were tight and my experience wasn't up to snuff. I worked as an Americorps member for a very small amount of money, but I was able to build experience that I would otherwise not have been able to amass so quickly otherwise. It was a wise decision to do. I knew I was living thin and had to incur some credit debt in order to pull through that year. I did go into debt, but the mistake I made was how I did it. There was too much restaurant spending and other expenses that could have been trimmed down to minimize the debt. That is where I screwed up. The decision to potentially enter debt in order to build my resume was the right thing to do.

Americans often change jobs several times in a lifetime, but it still can be hard to change your entire career. If you have worked in business for several years and want to pursue ministry, the arts or non-profit work, for example, it may require some gutsy "investing". This may involve some unpaid internships, student loans, or very low paying entry-level jobs to work your way up. It can totally make sense to do that if you are incurring those losses around a vision for your own growth, financial or otherwise. Only you can know for sure, but I will say this: Some prudence is in order. But also it is important to take risks in life, too. The wisdom is knowing when to do what.

If you are borrowing money and taking risks on your future without some kind of vision or plan for how that will come to fruition, you are taking quite a gamble. You may be suffering from some unrealistic belief that it's all going to fall into place someday. Certainly, some amazing people have stumbled into greatness with nary a plan nor an idea. I am not sure I would want to take that kind of gamble, though. If you want to achieve a goal, the best thing to do is have a plan. The odds are unlikely that you will able to achieve your goal without taking some kinds of risks, though, and among those risks could very well be taking out a loan. Or two.

The Bottom Line

So if you don't take out a loan, yes, you are saving yourself interest. But what could you have had if you took out the loan? Don't let loans stop you from financing your education, buying a home or starting a business. Those are the ideal places where loans are best used! Going into debt is not a bad thing at all under certain conditions. Its can be a reasonable and profitable thing to do.

While society would really benefit from some old fashioned frugalness, some wise, targeted investments are an essential part of a healthy economy. I do believe our society can use some prudence either way--knowing when to hold 'em, and when to fold 'em. So every decision has both a cost and a benefit. Every decision also has an opportunity cost--whether its worth it or not depends on the situation. The bottom line is: If you're going into debt, have a plan.