Why respecting debt makes sense

Why respecting debt makes sense

Debt requires careful handling. It can reap dividends and alternatively can create havoc. The temptation to fall prey to raising loans is ever present as additional liquidity is always welcome.

How we manage debt determines our financial strength and mental peace. Without debt the economy would not prosper and development would not occur. But it is full of risk if debt management is defective and lacks planning.

The end use of debt has to be constructive for us to see its brighter side. Therefore the decision to raise debt should be well thought out. It should be for creating a productive asset. We need to ask ourselves whether we really need the loan. Will it create assets and generate funds for us or will it be a drain on our resources.

The questions we need to honestly answer would be:

 Is the loan really required? Is it for something worthwhile or just for pleasure or worse is it to increase/support the monthly income?

 Has my spending overshot the available resources, can I reduce my expenses, do I need to check any impulse buying?

 Do I need to control my expenses; am I following the 50:20:30 rule while using my resources? (50% towards essential expenses, 20% towards savings, 30% for lifestyle expenses). This is a financial thumb rule often suggested to keep a hold over individual’s expenses.

To appreciate the impact of expenses, I am inclined to quote Benjamin Franklin– ‘beware of little expenses; a small leak will sink a great ship.’ In case of a shift from practising the above rule where have I slipped? In case raising of debt becomes inevitable then ask.

What is my debt situation?

Is there scope for having another loan?

 How do I intend to repay it? (never borrow if you do not know how to repay it timely). Remember that servicing a loan would bring you face to face with the following probable situations:

 You would have to sacrifice some expenses to make the monthly loan instalment repayments, if you wish to remain within your budgeted expenses amount
 You would have to ensure that there is no slip in the monthly payments; you can postpone certain expenses but you cannot avoid loan repayments; you are asking for trouble if you do so The cost of the asset acquired would ultimately be much more with application of interest.

 The asset would continue to remain pledged/mortgaged till the loan is fully cleared.
 The asset except property, would depreciate over the period of the loan.
 If the loan is for holidays, consumption the debt would be unproductive. Education loans are also full of risks as the productive use is uncertain.
 You might have to face recovery agents in case there is default.

 In a worst case scenario you might have to face litigation and forfeiture of the asset if the loan amount remains unpaid.

 Improper conduct of a loan would mean an adverse credit score; without a proper credit score your credit profile would not qualify for any credit facility and in times to come, even availing of utility services make become difficult.

It is not that taking a loan would invariably turn out to be so scary, but undoubtedly the adverse prospects are possible, if we do not have a proper plan and a supporting budget to take care of the repayments. We need to respect debt as the downside of poor handling may damage our financial position. Debt for debt sake is never recommended. We are mortgaging our future income when we take loans for serving our present wants and aspirations. Financial prudence is the key to effective management of our finances.

It is not the intention to suggest that all debt is bad; it can never be as otherwise banks would fold up. Economy would not prosper and there would no growth but the debt availed should be for creation of productive assets. Go for it if you have the financial means and a backup plan in place.

I would like to conclude with the following quotes:

‘When you borrow a lot of money to create a false prosperity, you import the future into the present’ and ‘Leverage brings you a glimpse of prosperity you haven’t really earned’.

(The writer is a banking consultant)

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