The tyranny of debt - Does it make sense to borrow?

Oran Hall, Contributor

As times get harder, many persons tend to borrow to be able to purchase the goods and services they usually enjoy.

Sometimes, the intention is that the situation will be short term and, thus, it should not be a matter to be seriously concerned about. But even a short-term situation may do some harm to the borrower's financial health.

Nonetheless, it is unwise to dismiss borrowing because it can prove quite beneficial. In cases, for example, where borrowing is used to acquire assets that generate a return that exceeds the cost of borrowing, it can be beneficial, but I doubt there are many cases in the current marketplace and market conditions.

Borrowing can be useful if it helps to improve the chances of getting valuable long-term benefits. Education is a good example, but the experiences of students who later struggle with loan repayments to the Students' Loan Bureau would suggest that there is not much value in that course. But once the loan-repayment period has passed, the real benefits of borrowing for education become more evident, if employment can be secured on a sustained basis.

Borrowing is also useful when purchasing an expensive asset, such as a home. The general trend for property values to increase over time and for the monthly payments to get proportionately less when compared to personal income also makes that an attractive proposition.

Debt can add up

But consumers should weigh carefully the cost of debt before committing themselves to borrowing. Even relatively small weekly or monthly payments can mask the high cost of debt.

Using your funds partially or fully to make necessary purchases can be very beneficial to consumers.

What is required is discipline to replace the funds borrowed from oneself. But some persons love to argue that the funds they borrow will be insured so their family will not have the burden of repaying the debt if they should die before the debt has been liquidated. How often does that happen? Credit insurance does not come without a cost in any event.

If it becomes necessary to borrow, borrow as little as possible, and certainly borrow no more than is absolutely necessary. Shop around and compare and take time to understand the terms. What appears attractive on the surface is not necessarily the most attractive loan offer. Seek guidance from other persons who have a good understanding of such issues.

Make the pay-back period as short as possible. It is true that the periodic payments are higher than they are for loans with longer terms. But the longer the loan repayment period, the more interest is paid. Consider this. The shorter the term, the earlier a serious dent begins to be made in the principal balance.

Opt for a loan that does not carry a prepayment penalty. You may want to reduce the term of the loan by paying the principal balance in full at some point or by making ad hoc payments to accelerate the reduction of the principal balance.

Ask the conditions that should be satisfied to make these early payments. Will it be necessary to give notice to the financial institution, for example? If so, how much?

Some lenders require borrowers to purchase credit life insurance but it is optional in some cases. Consider that only the sum outstanding will be covered in the event of death and not the original sum borrowed.

If, for example, you borrow $500,000, but at the time of your death the balance is $50,000, the amount payable by the insurance company is not $500,000 but $50,000. Which way do you want to bet - that the loan will outlive you or that you will outlive it?

Be careful with the credit card, which is so
convenient but so expensive. It can become a real millstone around the
neck, an unending life of making high monthly payments without
eliminating the debt.

Additionally, avoid incurring a
debt you will still be repaying after what it has been used to purchase
has stopped giving any utility. If the benefit to be derived from the
loan is short term, its term should be short.

Bear in
mind that as debt servicing costs increase, the money available for
other activities decreases. The effect of this is that as debt makes it
easier to live at a certain level today, it makes it more difficult to
maintain that level tomorrow.

The key word is balance
when considering incurring debt. It can start a cycle which is hard to
break. It can be destructive to financial well-being and it can
compromise health. If you must use it, use it wisely.

Oran A. Hall, principal author of 'The Handbook of Personal Financial
Planning', offers free personal financial planning advice and
counsel.finviser.jm@gmail.com.