Using Debt as a Financial-Planning Tool -- Not a Last Resort

A lot has been written about debt -- including by me. Debt remains the focus of our political and economic life, as personal and national debt has grown past all imagining. So let's look at the problem of debt, individual and collective, from some new angles to help sort out our understanding and, yes, our feelings, as well. For emotions of one stripe or another disproportionately fuel the engine of the debt train.

If you want daily evidence, look at virtually any news item. Doom and gloom over the direction of the national debt, the financial markets, home values, taxes, etc., leads to fear. When in fear, we seek comfort and reassurance, and that often leads to bad financial decisions regarding debt.

No doubt, fear over our financial security has been welcome fodder for the 24-hour news cycle. Robert Reich, the well-spoken former U.S. Secretary of Labor, said recently, "The good news is that things are getting worse more slowly." Thanks so much, Bob. Comments like these do little to help individuals find real security or rational solutions.

Maybe it would help to think of debt in relation to time: Current advantage vs. delayed consequences. On one hand, taking on debt can have the current advantage of helping to build financial security for the future. For example, a mortgage has the current advantage of allowing you to buy a home for shelter, and also providing you with a tool to build equity for the future. On the other hand, taking on a lot of credit-card debt now to splurge on such things as shopping, cars, electronics, etc., has the delayed consequence of saddling you with high interest payments later on items of depreciating value.

Either way, there are consequences -- some predictable, some not. Using debt as an opportunity is a plus, using debt for immediate gratification is a minus (a big minus if left unchecked).

It may not be possible for some to look at debt without emotion, but it is possible that debt can be used as a strategic financial tool. Here are two examples of how my financial advisor recently earned his considerable pay by helping me use credit wisely:

• First, at the bottom of the stock market last year my advisor mused that the market was abnormally depressed and would likely bounce back. So instead of cashing out some weak stocks to meet a sudden financial shortfall, my planner advised me to access some of our unused home-equity balance to pay the bills while the market recovered. The loan rate was low and the interest payments were tax deductible, so it seemed a prudent move. His advice proved wise: The market rallied back and not only did I avoid taking a large stock loss, but the capital gains more than made up for the cost of the loan.

• Second, my advisor urged me to make a long-delayed purchase of a new car. I’ve written about my 17-year-old beater, and although it’s still looks in remarkably good shape it was about to become a black hole for major expensive replacements. Also, an upgrade was advisable because many auto-safety features have come along over those 17 years. (And, I have to admit the idea of a flashy new ride proved irresistible.) My advisor said paying cash is always the cheapest way to buy a new car, but he noted that when using below-market, manufacturer-sponsored financing, the spread between the cost of the car loan and the likely return from leaving that money in the market would be worth it. Again, the market rallied back, and his suggestion proved to be a good one.

These two good pieces of advice helped me to creatively use credit to cope with current financial circumstances. My planner wasn't emotional about the decision to borrow, and he was able to trump my own squeamishness.

Debt exists, and always will, but we can be a lot smarter about how and when to use it. To do that, we need to start with a more formal basic financial education for young people on the sensible use of debt. Next, we need to practice using that knowledge with as little emotion as possible. (Otherwise we are all doomed to violate the first rule of being in a financial hole: “Stop Digging!") Finally, we need to recognize the importance of having a cash reserve, so that we debt is viewed a useful tool -- and not a last resort.

That's where we stand now as a country, though, and it is not pretty. But it's not too late, if wise heads prevail. And remember, as a country we do have a theoretical debt limit -- the Chinese just haven't told us where that level is yet. Doh!