How Debt Can Be Your Best Friend
Like guns or sleeping pills or Twitter, the vice or virtue of debt depends on the intentions of the user
Say it with me now: Debt is our way to a better life.
Wait, why did you fall out of your chair right then?
Oh I get it. You’re a skeptic, one of those people scared into fearing debt by your risk-averse parents and the recent financial crisis and the current shenanigans in Congress.
Well, the unfortunate reality is that an aversion to debt — that is, responsible debt — can seriously hurt you in this important phase of life where you’re trying to plan for your future.
The sooner you start embracing debt and its responsible use, the better off you’ll be.
For starters, start thinking about debt as simply a financial tool – like a 401k or a debit card. You can do great harm when you use any of these instruments the wrong way, but all have big benefits when used correctly.
Or put another way, debt is similar to guns or sleeping pills or Twitter accounts; the virtue of its use varies greatly depending on the intentions of the user.
Once you embrace the idea of debt as a tool, you can start to think rationally about how and when to use it — namely, when you have a big-ticket purchase that you either cannot or should not pay for in full up front.
The “cannot” category is easy — I mean, is it practical to wait until you have $100,000 saved up to buy your first house?
The “should not” is trickier because it involves careful assessment of the terms of a loan and the nature of your purchase.
Take a $900 sofa that will be the first piece of furniture in your adult life not purchased on Craigslist. You have $900…but what if the furniture store offers zero percent financing for a year? If you have the discipline to pay $90 a month, you’ll have the sofa paid off with two months to spare and give yourself much more wiggle room in your monthly budget.
Furthermore, if you can find that extra $90 a month — a mere $22 a week — then you won’t tap into savings at all.
In other words, financing (that is, “debt”) can actually increase your savings this way because instead of incurring a big one-time cost you can spread it out into a more digestible amount. Sure, I suppose if you have the discipline you could save that $90 a month all the same and come out even again…but most people spend the extra money they have — so why tempt yourself?
Zero percent financing is a no-brainer, but there are also instances when debt can save you money even if you incur interest charges.
Let’s say you have $10,000 and are shopping for a car for that amount. Should you finance the vehicle at 2% interest or pay with cash?
You may be inclined to pay with cash and “save” on the interest payments. But follow me on this math:
If you finance a car for $10,000 at 2% interest for five years, you’ll be paying $180 or so a month and at the end of your loan will have paid just over $500 in total interest — roughly $8.40 a month! (Here’s a loan interest calculator for you to plug in other amounts.)
Is it worth $8.40 a month to keep that $10,000 in the bank in case of emergencies?
More importantly, what are you doing with the $10,000 if you’re not buying the car? Because if you aren't making it grow in a CD or investment account, inflation is actually eroding the purchasing power of that $10,000. Simply sitting on that money does no good.
Think of a nickel in 1950. If your grandma didn't spend it but also didn't make it grow… well, what the heck good is a nickel in 2013? In that respect buying a cup of coffee would have been a better way to “save” that nickel, considering the prices lately at Starbucks.
Obviously, nobody in their right mind should put a bar tab on their Visa and forget to make the minimum payments. That’s not what we’re talking about here.
Hopefully these examples show that debt is a powerful financial tool if used right.
And best of all, if you use it right then lenders notice; that’s what your credit score is, after all. (You can get your credit report free once a year here, by the way.) So the more wisely you use debt the better deals you’ll get on future borrowing.
For a responsible person who uses credit wisely, this is a virtuous cycle you should start spinning as soon as possible.
Because in a few years when you have to make a huge purchase like a house or a minivan, a favorable credit score and your experience with debt will make life much, much easier.
So again, say it with me: Debt is our way to a better life.
Jeff Reeves is the editor of InvestorPlace.com and a columnist for MarketWatch and USA Today. He’s been all over financial media, from Fox Business to Forbes, writing about everything from investing to taxes to personal finance tips. Write him at firstname.lastname@example.org.