Debt is a tricky thing. It’s so easy to get yourself into it, hard to pay it off and some people don’t seem to be able to live without it. A necessary evil? Maybe. But I must say I agree with Dave Ramsey as I believe that most debt should be avoided.

My personal approach might be more radical than most people’s. I believe that debt should be avoided at all costs – apart from certain circumstances.

Car loan? No thank you. Pay for a purchase in instalments? Nah. Buy now, pay later? Hm, no. Of course not everyone shares the same opinion, and everyone’s situation is different. But when should you avoid and when should you borrow money?

Why avoid debt?

The concept of borrowing money is very simple. You borrow money today to pay for something that you don’t have enough funds to afford on your own. In exchange for the privilege of using someone else’s money to get what you want now you pay an interest on the amount you borrowed. It’s an easy concept and it’s easy to look at borrowing as the normal thing to do. After all, why wait and pay cash, when you can get whatever you want now for only a modest fee?

You see, the problem with debt is that it is EXPENSIVE. Even if you think you got a good deal at a low interest rate, make sure to factor in:

• How much you are actually paying in interest over the term of your loan
• How much you are paying in extra fees
• How much your asset is depreciating over the course of your loan. This is so important for consumer debt, and people often fail to take this into account.
• Opportunity cost. How much you would gain if you invested this money over the term of your loan? And over the long term?

Don’t forget the emotional and health costs as well. If a portion of your pay check is tied up in paying off debt, that means less money to deal with an emergency or an unexpected expense. It also means you have less flexibility to quit a job you hate, and a lot more fear of getting fired. This causes stress and can also affect your relationships. When people normalize debt, it tends to become a habit and can quickly snowball. The easiest way to avoid this is to say no.

Getting into debt has a lot to do with wanting things NOW. The best way that I know to avoid the debt trap is simply not to buy what you can’t afford in cash. Easier said than done, but it is really a mindset exercise. If you dig deep you will see that most consumer purchases can be delayed or avoided. Do your planning, save up, find alternatives and find joy in not wasting money.

What if I actually need something?

There might be situations in which debt is unavoidable. Maybe you need something urgent (and don’t yet have an emergency fund). Maybe you desperately need a car – transportation might be unreliable depending on where you live.

If this is the case, make sure you:

• Analyse and get the cheapest possible option. Do not just chuck everything on your credit card
• Do not buy more than you need (needing a car for transportation doesn’t mean a brand new SUV)
• Buy less than you can afford. Just because you can afford a $500 weekly payment, it doesn’t mean that you should.
• Pay if off as quickly as possible. Like your hair is on fire. The debt is eating away your money and future investments.
• Learn to manage your finances better so you can deal with future situations without having to rely on credit.

When should I borrow money?

Personally, I suggest avoiding debt at all costs. Except in certain circumstances. You see, there is a difference between consumer debt, and the so called good debt.

Consumer debt should be avoided, because all it does it cost you money and cause you stress. Car loans, credit card and personal loans cost a lot and can be avoided with good financial planning.

Good debt is debt that is considered an investment, and that usually has lower interest rates. Some of the circumstances in which debt might be smart are:

• Borrowing money for income-generating assets. This might include a rental property or a business. In this case, the income generated by the asset can pay for the debt while increasing your net worth at the same time. While this type of debt can be smart, it can also be a bad decision if your business doesn’t work out, or if you have problems with your rental property. In order to avoid this make sure you do A LOT of research, know your numbers well and be prepared to take risks.
• Borrow money to increase your earning potential. Your ability to generate income is an important asset. You can increase your earning potential by investing in yourself. What value could you add to yourself that could increase your income? This might be education or experiences. While it can be smart to borrow money to invest in your education, I would still advocate that you avoid it. Save up in advance if possible, pay as you go, and be smart if really do need to go into debt.
• Borrow money for assets that will appreciate in value. This again might include a property, a business and other assets such as artwork. When you use leverage to purchase an appreciating asset, the appreciation will be based on the total value of the asset, and not on your cash. After considering all costs, it can potentially offer great returns. Of course you need to do your research and know your costs well, as there is always risk associated with leverage. Investing is not gambling. Also, I would not recommend using leverage to purchase stocks, unless you are a sophisticated investor taking a very calculated risk that you can afford.
• What about my home? There are different opinions about this one. Your primary residence is not an investment, unless you specifically plan to sell it for a profit or rent it out. Property prices do not always go up and owning your primary residence is not always the most optimal use of your money. However, prices generally do tend to go up (at least keep up with inflation) and interest rates are usually low. There is also an emotional aspect to owning your own home that needs to be taken into account, security, autonomy, etc. It is not an investment, but considering low interest rates, appreciation, and the emotional aspect, it can be a good choice to borrow money for your home. I would however suggest making extra payments as often as possible. Don’t forget that it is still debt (big one) and it can have a big impact in your finances over time.

I hope this post has been helpful to you. Do you have debt? Have you ever borrowed money and regretted it? Let me know in the comments below!