Between the biggest international corporations and individual citizens, financial concepts and goals remain the same: make more money than you spend. Similarly, businesses and people alike need to make use of debt, credit, and loans. Good debt, bad debt, and everything in between, the key to financial success is managing debt of all forms.
Many people think of debt as a four-letter word. But debt isn’t all bad. One of the most important facets of financial literacy is understanding that debt, loans, and credit are all different sides of the same triangle. The mortgage, business loan, and credit card experts here at Troy Bank & Trust help customers better understand the good, the bad, and the ugly when it comes to all things debt.
The global economy makes use of countless forms of debt. For customers here at Troy Bank & Trust, we tend to focus on the most common forms of debt and credit used by everyday citizens, families, and business owners. A few of the most important forms of debt include:
- Mortgage loan: Also known as a home loan, mortgage loans allow individuals and families to purchase homes without the need to pay in cash.
- Home equity loan: Folks can take out loans against the equity they have already put into their homes through mortgage payments.
- Business loans: It’s difficult to start a business without capital. Business loans help entrepreneurs purchase basic supplies and hire employees.
- Personal loans: Sometimes people need help getting out of a jam, or to make a big purchase. Personal loans can be quite useful in many such situations.
- Credit cards: Living without a credit card is almost unheard of these days. Credit cards allow you to balance your budget without needing cash up front for every single purchase. They’re also crucial for helping folks build credit, which is necessary for mortgage and business loans.
- Margin loans: Many people use their retirement portfolios as collateral for loans. Margin loans are popular among folks with significant investments in stocks and bonds.
As you can see, anytime you borrow money, you are taking advantage of debt.
Debt and credit are absolutely necessary to achieve financial success. Few people can go to college, buy a home, start a business, or make everyday purchases without taking out loans and using credit cards. Managing your debt correctly, however, makes all the difference.
Managing Debt: The Good, The Bad & The Ugly
Good Debt-Bad Debt
Let’s play a game called good debt-bad debt. We’ll describe a series of scenarios, and then we’ll decide together whether they exemplified good or bad decisions to borrow money.
- Jack wants to take out a personal loan, also known as a consumer loan, to purchase an engagement ring. Jack is looking to buy a ring worth three months’ pay as a restaurant manager at a well-known chain. He’s got a consistent history of credit card repayments and contributes regularly to a 401K plan.
Good debt! Sure, engagement rings are mostly a sunk cost. We don’t resell them or use them as investments. However, they’re part of a rich marital tradition that marks an overall values-oriented individual. Furthermore, Jack is responsible with his money, his job, and the amount spent on his ring.
- Four years out of college, Jill is between jobs. She hasn’t found a clear career path, hopping among entry-level positions as she works toward building a copywriting portfolio. She’s still got $100,000 in student loan debt and has trouble paying her credit card each month. Jill decides she wants to invest in solar technology companies. If she does well, she’ll have more breathing room to work on her portfolio. She decides to take a margin loan on the stocks and bonds she inherited from her grandparents.
Bad debt! First of all, margin loans are always risky. If the market crashes, Jill may be forced into a margin call, meaning she must put up more cash to back up her borrowings. Secondly, rather than working to pay off her student loan debt, Jill is risking thousands of dollars on a new, unestablished industry. Meanwhile, her credit card debt is accruing anywhere from 15-22% annualized. Meaning, Jill’s solar stocks will need to perform at least as well to make them a sound investment. Chances are, Jill won’t make out well on this investment. Continuing down this path will make her vulnerable to predatory lenders, who provide quick loans at exorbitant interest rates.
- Raquel lives in the same house she and her husband bought twenty years ago. She owns a graphic design business that has its good years and its lean years. Generally, her mortgage is comfortably affordable. She and her husband have no debt outside their mortgage. Raquel’s husband, a retired government employee, was recently diagnosed with a serious illness that requires very expensive medical care. Raquel can’t afford the medical payments. However, they’re just three years from paying off their home, having made timely monthly payments, and then some. Raquel and her husband decide to take out a home equity loan to subsidize the medical bills. Good debt! First of all, nothing is more important than our health. The money needs to come from somewhere, and not everyone is fortunate enough to have wealthy friends or family. As long as they don’t start spending that money on unnecessary expenses, this is an excellent plan.
Secondly, Raquel is still making a living, and her husband has a government pension. Having paid off most of their mortgage, an equity loan is simply an extension of that mortgage. Though tough to swallow, if Raquel’s husband receives the proper treatment, they will be back on track in no time.
The Bottom Line: Assets Vs. Liabilities
In the end, it’s up to you to decide what’s worth borrowing for. All that matters is whether you’re making more money than you’re spending. If you can afford your mortgage, credit card payments, and basic needs, you shouldn’t have a problem when you need a business or personal loan.
Additionally, it’s always smart to leave room for emergencies—such as our example with Raquel. Without paying down their mortgage over all those years, Raquel and her husband would not have been able to afford an equity loan when they needed it most!
Troy Bank & Trust wants to help you with your debt and borrowing needs
As a local independent bank, banking with us means you’re also helping your local economy, and we make your banking experience more accessible. Allow us to help you with your checking and savings needs and give you the peace of mind that planning for your loved ones brings. After all, we are “the only bank you’ll ever need.” For more information on working with us for your business needs, visit Troy Bank & Trust here, or reach out to us by phone at 334-566-4000 or 888-258-8769.