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Debt - A Useful Tool

When it is working for us, debt is a wonderful tool. Without it, the family home would be something most of us would not be able to consider until we approached retirement. Other big ticket items such as the new car would require years of saving, before they could be purchased and enjoyed. And in times of emergency or where unexpected spending is required (Ie. To cover the unexpected realities in life, like illness or injury), short term debt such as credit cards offer us tremendous convenience and flexibility.

 

Debt is not necessarily a bad thing. In fact, this is so much the case that in business, not having debt is often seen as a bad thing. It means that you are not leveraging off your capital and getting efficient use out of it. With the responsible use of debt, we can do so much more in our lives than is possible without debt

 

Debt - When It Becomes A Problem

So when does debt become a problem then? This, my friend is pretty simple. There is a cost to debt. This simply, is the interest payments accruing to a debt. On an individual level, debt becomes a problem when the interest accruing to a legal entity's (Ie. person, corporation or trust) debt is more than their income generating ability to pay for it. When this happens, the accruing interest adds to the underlying debt. Over a long enough timeframe, the debt will grow into a size that is large enough that it becomes impossible to repay.

 

In the above situation, no-one wins. The entity who has the debt will go bankrupt and lose everything. The lender will get whatever they can from the bankrupt entity and typically ends up with a bunch of assets they do not want and which distract them from their business of lending money to responsible organisations. Often legal proceedings are involved, which cost money and just leaves less for both the lenders and borrowers. No-one ever wins when debt becomes a problem.

 

On occasions, there are enough people and organisations for whom debt has become a problem that it can cause global financial turmoil. The credit crisis of 2007/2008 is a good example of this. So many people borrowed money they could not finance that it caused massive financial corporations to go bankrupt and the global economy to falter. This is a good enough reason for me to take personal responsibility for my managing my own debt, rather than blaming banks and governments. In the end it really comes down to you and me managing our affairs responsibly.

 

Managing Debt Responsibly

Managing your debt should be a simple thing. If you do not know where to start, you can just follow the following steps:

Setting personal rules such as the above are simplistic sure, and they never cover every eventuality. But if everyone took responsibility of their own finances and followed such or similar rules when borrowing, a whole lot fewer people would get into financial distress and our economy would get into trouble a whole lot less often.

 

Its amazing how many people do not even know how much money they have to fund debt before they borrow these days. Its more amazing how many of these people blame the government, banks and "the capitalist society" when their affairs fall apart, when all they had to do was take responsibility for managing their own finances from the start.