{"id":2882,"date":"2017-11-02T12:14:09","date_gmt":"2017-11-02T12:14:09","guid":{"rendered":"https:\/\/www.foxymonkey.com\/?p=2882"},"modified":"2017-11-02T12:25:47","modified_gmt":"2017-11-02T12:25:47","slug":"debt-friend-or-enemy","status":"publish","type":"post","link":"https:\/\/www.foxymonkey.com\/debt-friend-or-enemy\/","title":{"rendered":"Is Debt your Friend or your Enemy?"},"content":{"rendered":"

\"Good

Unlike many normal people, I’m fascinated by the subject! Am I so boring? :)<\/p>\n

Although I’ve never been into debt myself, I have seen the problems it can bring first-hand through my family’s recent history. The fact that people are\u00a0drowning in debt is not always their fault. Sometimes it’s due to society values or peer pressure or simply, being bad at managing our wallets. Despite that, it’s our<\/strong> ultimate responsibility to get out of bad<\/em> debt and protect ourselves against that.<\/p>\n

When debt is your friend<\/h3>\n

Not all debt is bad. Which is a very important point in understanding debt itself.<\/p>\n

Educating yourself on debt is actually better than making more money.<\/p><\/blockquote>\n

When a small business takes a loan to buy a minivan and expands their business, it makes a reasonable decision. The business will be stronger and stronger profits will pay for the debt. This is called\u00a0good<\/em> debt.<\/p>\n

Similarly, when the bank helps you to buy a rental property, you get the\u00a0flat at a fraction of the real price and can rent it out for a high price. Tenants pay you rent, you pay the bank some money and you keep the surplus for yourself.<\/p>\n

Debt is your FRIEND because your money grows while it shrinks. Good debt helps you leverage<\/em> your earning power.<\/p>\n

When debt is your enemy<\/h3>\n

\"Debt

Usually, though, people see debt as a trade for pleasure. College kid graduates and borrows \u00a32,000 to go on holidays. “Life’s short, I will pay later”.<\/p>\n

It’s not only the college kid. Throughout our lives, people pay 18% interest to buy a car on finance. You just bought a depreciating asset and now debt is your ENEMY.<\/p>\n

Taking on bad debt means that the money you make work against you not for you. I’m happy when people take debt because my peer-to-peer lending accounts grow faster. This may sound\u00a0mean but hey, if that’s what people want to do I’ll not prevent them from doing it.<\/p>\n

Bad debt is very risky when taken early in life. My manager just bought a \u00a360,000 Tesla car. He’s 50 years old, he owns his house mortgage-free and his finances are in a good shape. I know that a new top electric car will make him happier.<\/p>\n

Although I don’t agree with the decision to buy a super expensive car just to drive around once a week, I can understand it. IT’S OK for him to buy a new Tesla on 3% finance because the impact – given his salary and his situation – will be small.<\/p>\n

IT’S NOT OK for someone who’s living paycheck to paycheck to buy the Tesla just because someone approved their loan. There are huge risks. Oh yeah… The risks.<\/p>\n

The risks of bad debt<\/h2>\n

Debt will become more expensive<\/strong><\/p>\n

For the past few years debt has become very cheap and accessible. This is both good and bad. It’s very easy to get money because interest rates are very low.<\/p>\n

This is where the tricky part is, though. Because interest rates are very low (0.5%), the debt will become more expensive if interest rates rise in the near future. By the way, the Bank of England decides what happens to interest rates, not us.<\/p>\n

Just to give you an example, A \u00a3450,000 mortgage with a \u00a350,000 downpayment currently costs \u00a31,907 per month at 2% interest. If interest rates rise by 2% in the next 5 years, the next “fixed 2-year term” negotiation will cost you \u00a32,375.<\/p>\n

I’m not saying don’t buy a house. I’m saying if you will,\u00a0know that you should have a margin of safety because borrowed things will become more expensive in the near future.<\/p>\n

Stopping you from achieving financial independence<\/strong><\/p>\n

You prevent yourself from getting ahead on the journey to financial independence<\/a>. Instead of getting a free salary by having invested money working for you, you suffocate it. You have your money working for someone else – the lender!<\/p>\n

Having future regrets<\/strong><\/p>\n

How many times have we thought: Oh this was a stupid decision spontaneously taken. I wish I could go back in time and revert it.<\/em><\/p>\n

Now is that time. Make debt your friend, not your enemy!<\/p>\n

How to avoid debt<\/h2>\n

\"How

You may already have debt or consider taking some. Regardless of your current situation, If you follow the steps below, you’ll save yourself from future troubles.<\/p>\n

1. Start recognizing good debt from bad debt<\/h3>\n

You know when you’re buying something that will increase in value. For example, a home usually increases in value with inflation and market demand. Taking a loan to buy a house is not as bad as taking a loan to buy a depreciating asset, like a motorbike.<\/p>\n

Credit card balances is another form of bad debt because they’re usually used to buy consumer goods half of which go out of fashion 6 months later.<\/p>\n

2. Validate your business idea before taking on any good debt<\/h3>\n

Good debt can easily turn into bad debt if not managed correctly. For example, you take a loan to buy the van for your business. Meanwhile, your sales drop and you cannot pay it back.<\/p>\n

I still remember a story I heard about 2 friends who wanted to start a transportation company.\u00a0They wanted to take a bank loan to buy two coaches. The bank was happy to give them a \u00a330,000 loan as long as they put their parents’ house as collateral. An extremely risky proposition!<\/p>\n

What they could have done instead, is to first check if the business idea is going to fly. How? By renting their friend’s bus for a few weekends and paying him a commission. That way, they can reduce the risk of taking a huge loan for something they don’t know it’s going to work or not.<\/p>\n

Not all problems are solved with money. Try to see if taking good debt will indeed help you leverage the gains. If yes, I’m all in.<\/p>\n

3. Avoid lifestyle inflation<\/h3>\n

Lifestyle inflation is an interesting one. As people get higher salaries they think they’ll become happier if they spend more. What do you mean, Michael? It doesn’t work like that? No, it doesn’t.<\/p>\n

Ask yourself first: Will it make me happier?<\/p>\n

Science says that just because you will spend more it doesn’t mean you will get more happiness out of it. Having a social circle and friends, being proud of yourself (self-respect) and staying healthy will make you happy<\/a>.<\/p>\n

But speaking of debt, people that earn more can also BORROW more. They’re more creditworthy because they make more money. This is a double-edged sword.<\/p>\n

Because you have more money it doesn’t mean you can put yourself deeper in debt simply because you’re more creditworthy now.<\/p>\n

I fell into this trap when I doubled my salary. I could suddenly borrow a lot more and I almost bought a house<\/a>\u00a0at the peak of the London housing market.<\/p>\n

4. Track your spending<\/h3>\n
\"Monzo