Posted by Robert on August 15, 2011
Some commentators on personal finance like to repeat that there’s good debt and bad debt. They talk as though the nature of the debt itself changes, which is nonsense. Debt is debt, and adding good debt or bad debt to a decisions doesn’t make it a good decision or a bad decision. Debt is a magnifier, used to leverage resources. Debt will magnify the outcomes of good decisions and bad decisions equally.
If the outcome of a decision progressed in a straight line (eg. getting consistently better and better or worse and worse), it would be simple to act in ways that produce good outcomes. But that’s not normally the case, and our fortunes often bounce around, going from better to worse and back. When debt is used to magnify the outcomes, this cycle might produce ruin in an storm that otherwise could be waited out.
As an example, let’s consider a person who buys a car. They have a steady job with a healthy paycheque, but they have no savings. They are faced with two choices: save for the car from each paycheque or buy a car using a loan. Suppose they choose to save $500 per month for a year, or they can get a bank loan that will charge $500 + $25 interest per month for a year. The interest cost makes the loan a less efficient choice, but the car can be enjoyed now, not one year in the future. The problem comes if the employer has a problem with their salary payments and is a week late with a single paycheque. In the “saving” scenario, the employee can dip into their savings, postpone a deposit to the car account, and continue successfully. In the “loan” scenario, a single missed payment might cause the bank to repossess the car, causing the money already paid to be lost.
The risk of borrowed money exists regardless of the purpose of the loan. Whenever a loan is arranged, the risk of default should be protected against by having the ability to make payments (or complete repayment) if other sources of income fail. If a person is satisfied that they are suitably protected against the risks of a loan, they can decide whether or not the purpose of the loan justifies the cost.
The problem, it always seems like a good idea at the time (or no one would ever take on debt). I don’t think it’s always easy to identify good debt, however. I recommend starting from the assumption that debt is always bad. From there, debt may be acceptable if it is an investment in producing future income in excess of the interest cost. As an example, buying a business using debt could make sense. The income from the business should pay the investor’s salary, the interest on the debt and a little profit. Buying a car could be good debt, if it makes it possible to get a job with a generous salary. Buying a more expensive car than necessary mixes bad debt with good debt. Buying a house isn’t really good debt except that it avoids losing money by paying rent; it still doesn’t make sense to buy more house than necessary.
When do you think student loans good or bad debt? Have you had other debt that you consider “good” or “bad”?
This post is now part of the #323 Carnival of Personal Finance.
Posted by Tim Stobbs on June 29, 2011
It’s officially summer here now with the forecast high finally into the 30+ range right before the July long weekend. So now a lot of people start heading out to their cottages/cabins more often and their guests start to think: I could get used to this and vacation property lust starts to kick in.
Despite the initial reaction to the contrary I do get vacation property lust myself once in a while. My parents have had a cabin now for about a decade so I’ve been very familiar with the lifestyle and even I have to admit there is something about the place that is just relaxing to be at.
Yet what is is really like to own a second property? Well to be honest from what I’ve seen it is a bit of pain in the ass if you already have a house to look after. Maintaining two sets of yards sucks when you have a short summer already, you will likely have a little trouble remembering what is in each fridge, you will wash a lot of sheets if you have guests, and you can bet your insurance bill just got a lot higher with another property. Yet is it worth it?
The answer strangely enough can be: yes. You just have to accept up front that a second property will not be an investment, but rather a decision purely based on what makes you happy. Just don’t have any delusions about the decision being a financially smart one. Unless you have a huge annual vacation budget already and are willing to give up almost all other travel, you are likely not to break even. Also your ongoing costs will likely be substantial so your retirement plans will also likely take a setback if you choose to have that vacation property.
Yet a second property doesn’t have to be so bad with a little careful planning. I’m familiar with one family that recent got a little lot in a wooded valley just 15 minutes from their house. The yard does not have a lawn to maintain and it is just big enough to have a trailer on the site. So their total investment is a mere $60 to $80K to have a place they can visit every single weekend in the summer if they want. It is somewhat of an odd setup, but it does keep their costs down and keeps in mind the big issue of having a cottage is making sure it is close so you use it.
So if you really want that vacation property, go ahead and look at your options. I would caution that you should interview several existing vacation property owners prior to buying to make sure you know what you are getting into. Do you have a cottage or cabin? If so, it it worth it? If not, do you want one?
Posted by Dave on June 14, 2011
This is a guest post by Dave, who is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any. Dave is from Ontario and is working towards his CGA certification.
Sometime in the middle of the 40+ hours of studying for a taxation exam I wrote last Thursday I gained a roommate. My sister moved cities and is now living with my wife and I for the foreseeable future as she can’t afford to live on her own due to her finances (debt) being out of control. It seems that in the couple of years since she got out of college she has managed to rack up a considerable amount of debt, to the point that living by herself at and being able to eat is now a choice between the two.
So, I have essentially become a “parent” to a 24-year-old girl. From a financial perspective, it is most definitely not ideal because of the extra cost of supporting another person. It’s nice hanging out with my sister, since the last time we lived together was when she was 11 and I was 18, which meant we really didn’t have much in common, so we have a chance to connect now as adults.
Due to her financial state and the fact that she is now living for free in my house we have essentially taken over running her finances, mostly through setting up “rules” that we expect her to follow. If she doesn’t follow the rules, we’ll give her a couple of months to get first and last month’s rent and she is welcome to live her life how she would like.
So, what are the rules?
1) Pay off the debt as quickly as possible. We looked at her monthly expenses, her wages at her current job, and her debt. We gave her $50 a month to spend on whatever she wanted and told her to the rest needed to go to pay down her debt.
2) Follow Up on progress. We told her that we would like to see a copy of her pay stub and credit card statement to ensure that she was doing what she said she was doing…..We figure if we are going to be supporting a roommate we would like to ensure that she is carrying out her end of the bargain.
3) I’m not the bad cop. Not really a rule, but we explained that we weren’t the bad guys here. What we are intending to do is to help her get out of debt, an opportunity to start fresh – we would prefer that she takes it and not resent us for being the “heavy” in this situation. I’m sure at some point she will, but we thought we would discuss it prior to it happening.
So far (it’s been a week) the arrangement has been agreed to, I’m not sure how it will go over the next year or so she will be staying with us, I guess we’ll have to see. My wife and I understand that someone who has lived with very little financial structure or discipline this will be a big change, but we hope she makes the most of the opportunity.
Have you helped a family member out before? How did it work out?
