Part 1: The Nature of Debt
Let me first be transparent. As a financial consultant, I help businesses borrow money. More than half of my life, I have been helping business people borrow money and I get paid for that. It would seem then that I am the last person who should be answering the question- how one can get out of debt. However, because of my experience, I have insights on the subject that might help.
Instead of just saying outright that one should not ever borrow, my exposure veer more towards teaching people what I know about debt, how to use it wisely, and how to be freed from it.
Let me illustrate this point. I tell my son, don’t ever drive a motorcycle because it is dangerous. That is because I have never tried driving or even riding a motorcycle. I have seen motorcycle accidents and I don’t know how to prevent those. The only wise advice I can give is a simple “don’t”.
But one who drives and rides motorcycles may have a different view. He may be in favor of driving motorcycles because he knows how to avoid accidents and teach others. And because he knows everything about motorcycles, he can get the most mileage out of it, compared to myself who may not get anything but accidents.
This explains why my views are different from what you usually hear from others who say no to borrowing outright. That does not mean I am saying that they are wrong. I believe there are no right or wrong answers when it comes to a lot of issues such as this one. There are only right or wrong application. I believe it is the principles that help us apply do’s and don’ts correctly. So, we should discuss principles.
But first, let me tell you, my experience with borrowing is not that all rosy. I have seen companies go under because of heavy debt burden. During the Asian financial crisis of 1997, I saw families lose their houses. I have seen how wrong decisions can affect harmony in the home.
But then, I have also seen companies prosper because of a debt that helped them grow their business and generate more income which paid off the loan. I have seen families, including mine, acquire houses which they couldn’t do without borrowing. I have also seen businesses without any debt that went under.
These varied outcomes do not prove that borrowing is the source of the problem but something deeper than that. I believe a lot of times we put blame on the act of borrowing when in fact, poor management is the culprit. In the first place, a good manager always end up paying his debt. That is because a good manager knows when to borrow and when not to borrow. Likewise, a responsible lender knows when to lend and when not to.
So, to simplify, I do not recommend borrowing unless the person is a good manager of his current resources. This means that a person who mismanages his present resources should not manage debt or money that belongs to others. I guess that sounds logical.
Here are Basic Principles to go by:
Principle #1 – Money lent is money entrusted to a borrower who values the trust bestowed on him.
Principle #2 – Money has time value which means it should at least earn interest. So borrowing is only recommended if borrower can multiply its value so he can return the money with interest and retain additional value for himself.
Principle #3 – Usurious debt makes the borrower a slave to the lender. Avoid it as much as possible. In my opinion, interest rates as high as 3% per month are usurious.
Because of my exposure to banks, I have also learned how they assess borrowers whether or not they will be a good candidate for a loan. We can learn from them. These are the criteria they use:
1. Character – Is the borrower trustworthy? They see red flags when they see flashy cars and luxurious lifestyle, rumours of having a mistress, frequents the casinos, is into politics, etc.
2. Capacity to pay – Will the money be put in a viable investment that will generate sufficient income to pay the loan? Or is the borrower’s present income sufficient to cover loan amortization? If not, then they see no point in lending.
3. Credit history – Does the borrower’s record as far as his previous borrowing demonstrate trustworthiness and competence? They are sensitive to court cases, especially those that concern money.
4. Collateral – Is the borrower giving the lender enough security to cover himself if the borrower fails to pay the loan? This may be in the form of collateral e.g. a real estate mortgage, or an asset that can be sold, or a sure collectible that can be assigned to pay for the loan.
These are what most formal lenders call the 4 C’s of credit. If one takes a deeper look, the system makes the borrower suffer the consequences if he borrows wrongfully and cannot pay.
The bible says that a good borrower will pay for his debt according to the agreed schedule. So, the key is not to borrow if there is no assurance of being able to pay on time.
So there you go. The problem lies not in borrowing per se but the unwise lending by the lender and mismanagement of debt by the debtor.
With regards to usurious interest rate, this in my opinion includes the interest rate credit card companies charge when we extend the term of payment or when we are past due which can be a minimum of 3.5% per month.
A wise borrower pays the lender back and ends up with a higher asset value than before. This means that he has made use of the debt wisely and multiplied its value and then paid back the lender with interest. Both parties end up winners. Paying 3.5% interest rate monthly seldom make the borrower win. He ends up being a slave to the lender.
To summarize, the issue is not whether borrowing is wrong or not. The issue is whether or not the borrower will be a good steward of the money entrusted to him by the lender. This involves the borrower returning to the lender at the agreed time, the money entrusted to him with interest, and retaining additional value for himself.