A One Lapper recently shared his financial reservations around getting married. In a later post we consider the foundation he needs to protect the assets he already has, including his ability to earn an income.
This week we look at the role debt would play in his decision. He has two concerns regarding debt, “My girlfriend has study debt and car debt. Should I, instead of saving for a wedding, assist her in paying off her debt? This will enable her to help me save for the wedding. Should I get debt to finance the wedding? I hate this option, but it is an option.”
Is debt good or bad?
Debt can help you reach your financial goals, or cut you off at the knees. Luckily there’s an easy way to know whether debt is good or bad: good debt helps you to buy or earn assets. Bad debt is used to pay for your lifestyle.
In the One Lapper’s case, his girlfriend’s study debt is good, because it will help her earn more money in the future. Debt to pay for a wedding doesn’t help the couple earn more money in the future, so it’s probably not a good idea.
Car debt is somewhere between good and bad debt. Most people can’t afford to pay cash for their first car, but they need a car to get to and from work. Getting to work is a way of earning money, but you are unlikely to sell a car for more than you paid for it. That makes it an income-facilitating asset that loses value over time.
If the car is helping you earn more money than it’s costing you to pay off and run, you’re ahead. If you are working to afford the car, you are behind, because you won’t be able to make that money back when you sell it. For that reason, it’s a great idea to buy a car that can get you where you need to go as cheaply as possible. Forget the leather seats and never opt for balloon payments.
What’s so bad about debt?
Debt is when we use other people’s money to pay for things we can’t afford. The fee we pay for using other people’s money is called interest and it’s the reason why debt is bad news.
The amount of interest you have to pay has to be added to the amount you borrowed, which means what you bought costs more than you think. If you borrowed R100 at 20% interest, you’ll pay back R120. Stealthy Wealth explains how to work out percentages in this article, using VAT as an example.
Luckily interest is due on the money you still owe, not on the original amount you borrowed. If you don’t take on new debt, your interest due will be worked out on a smaller amount of money each month. For example, if you borrowed R100 two months ago and already paid R20 back, you will only be charged the 20% interest on R80. This is why it’s a good idea to pay back your debt as soon as possible – it helps you reduce the interest due and gets you closer to the sticker price.
Can I have debt and be financially healthy?
Debt doesn’t always mean you are in trouble. If you use debt to buy assets that you can sell at a profit in the future, it can be a powerful financial instrument. Remember, financial wellness is about accumulating and protecting assets. If you are using debt to buy financial assets like bonds and shares, it might be a good idea to speak to a financial advisor who can help you calculate how much risk this adds to your portfolio. Remember, debt has to be deducted from your assets to calculate your net worth.
Even short-term debt is sometimes a necessary evil. It’s not advisable to use debt for indulgences, but if you’re unable to avoid it, pay it back as quickly as humanly possible. Resolve to pay off what you owe completely before buying something else on credit. Keep track of how much things you bought on credit are actually costing you. Try not to have more than once source of debt. It makes it much harder to keep track of what you owe and how much it’s costing you.
If you are already in debt, you might be struggling to get out. That’s because of how interest payments tend to snowball on running accounts. The best way to start making a dent in debt repayments is to stop adding new debt on top of existing debt. Try to find ways to reduce your cost of living significantly, if only for a short period, to make a dent in your debt.
Should I help someone else settle debt?
Unfortunately debt is often a symptom of bad lifestyle choices. The overly-indebted tend to underestimate the impact debt can have on their finances. In the One Lapper’s case, paying off their existing debt sooner in order to save up for the wedding of their dreams is better than creating new debt to pay for a wedding. That said, if you are paying off someone else’s debt, draw up an agreement stating who is liable for what should the relationship come to an end. A financial advisor could help you work this out.
Being outstanding with your money doesn’t have to be hard. This series of articles will give you all the tools you need to get your house in order to start investing. Written by Just One Lap and sponsored by OUTvest, this series is the ultimate guide to outstanding money.