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When Does It Make Sense to Borrow?

Black Belt Shopper (featured column)
by Larry Wiener

Most of us would agree that debt is the enemy of personal finance. Almost none of us, however, are able to become homeowners without borrowing and home ownership certainly is a benefit. Many of us need car loans and many can point to other very legitimate reasons to borrow.

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Sam and Sally Spendthrift were out for a drive one Sunday. They passed by the Buy-It-Now Furniture Store and decided to stop in. There they decided they were tired of their oak living room set and wanted maple. It turned out the store was offering one year of free credit and decided to buy. They celebrated their purchase with an $80 dinner. They didn't have the cash with them and the checking account was low, so they put it on their credit card.

When they came home, they found the water heater was gone. Two days later they needed a new clutch. They were cash-poor and the addition of those expenses, along with the $80 dinner and now the payment for the new furniture stretched the budget thin. Two months later when Sam, an account executive, lost a major client, they found themselves in big trouble.

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Thomas and Teresa Thrifty realized that their car was not long for this world. They started saving $300 a month for a new car hoping that would help them when they did have to buy a new one. They started researching the different models and found the one that was right for their growing family. They started researching the different types of financing available.

Ten months into their plan, they noted that the car was burning an increasing amount of oil. Their mechanic told them it would need a $2500 engine overhaul and that it probably wasn't too many more months until it would need a new clutch for $700. And a new alternator might not be too far down the road. They found a gently used car, put $4000 down and financed the rest through their credit union. When they could, they paid extra and owned the car free and clear in 14 months.

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Look at these two scenarios and you see two different approaches to borrowing. The Spendthrifts were impulsive, didn't do research, and were borrowing for wants rather than needs. The Thriftys' planned ahead. They did research. They were borrowing for something they really needed. They sought to minimize borrowing cost by saving as much as they could and eliminated their debt as soon as possible.

Most of us would agree that debt is the enemy of personal finance. Almost none of us, however, are able to become homeowners without borrowing and home ownership certainly is a benefit. Many of us need car loans and many can point to other very legitimate reasons to borrow.

Some absolutists say that you should never borrow except to finance appreciating assets, such as a home, home improvement, or a business. That often works for people, but I recently heard about another way to look at borrowing that makes a lot of sense. I would like to share that with you.

Borrowing vs. Financing

Recently I attended a presentation put on by the American Baptist Credit Union. One of the booklets distributed distinguished between borrowing and financing.

Financing, the booklet said, is a transaction in which a person uses another person's money for a purpose that will add value to the person's life long after the term of financing is over. For example, people like the Thriftys who have a car that is soaking them financially and can't buy for cash need to address the situation.

Other examples of financing would be home mortgages, home improvement, and starting or expanding a business. Financing always has to be beneficial to both parties. The financier receives reasonable income and the financed gets something that will add long-lasting value to his or her life. In order to get that value, the financed would need to comfortably fit the payment into his or her budget while maintaining a reserve, staying afloat, and having a little extra to enjoy life.

Borrowing, on the other hand, doesn't necessarily add long-lasting benefits and often enslaves. The Spendthrifts above might enjoy their new furniture, but were paying premium prices. They were enslaving themselves to pay for a luxury. They will not enjoy their furniture or many of their other possessions if they are in constant anxiety about how they are going to make the payment.

The Spendthrifts would do much better to save a little bit each month for new furniture while still using their old furniture. Then, as they saw the furniture they wanted at good prices when they had the cash, they could buy the pieces and really enjoy them.

When You Are Financing

Obviously, any time you are going to finance a purchase, it will be a major one. You don't want to make a major mistake. Here are some tips to make sure your purchase is a wise one.

Research the item thoroughly. Make sure that the item you are buying really is the one to meet your needs and that it is of good quality. Consumer Reports is a good source to help you find information on cars, a frequently financed purchase.

Consider the timing of your purchase. You may be able to avoid financing and buy for cash by waiting a little to make your purchase. If, for example, your dryer goes in the summertime and you live in a dry climate, you might want to consider not using a dryer for a couple of months, making the payments you would make to finance a dryer to a dryer fund and then buy a dryer you see on sale when you have the money.

Make sure you are able to afford the financing. One commonly made mistake is this: A family sees a house in an area that is experiencing rapid appreciation in housing prices. They figure they can't afford to wait and buy more house than they can afford, figuring it will go up in value and that their income will rise. Then an unexpected emergency comes and they are financially out of control. When you are financing a purchase, make sure you can afford the payment today, not at some future time.

Research sources of financing. Financiers vary greatly in interest rates and other terms. Research banks and other sources. Consider credit unions you are a member of or are eligible to join. Read the fine print of any contract that seems too good to be true. It probably is.

When You Are Tempted To Borrow

Banks and others are anxious for you to borrow. Here in California a major bank is advertising for people to borrow against their home to buy a boat, a move that would put many people in great jeopardy and postpone the financial freedom that comes with little or no mortgage. The media are always suggesting that we need some large item or another and some of us are out to impress our friends and family with what we have. A little borrowing may be necessary in some emergency situations, but this should be minimized. Here are some thoughts:

If you are in the more month than money syndrome assess your situation to see what you can do to improve your cash flow before you do any borrowing. Can you start couponing to decrease your grocery bill? Is there a way to bring in some extra income? Can I bring lunch to work rather than buying? Can I carry less cash so I won't be so tempted to spend money?

Consider repairing an item rather than replacing it. If your refrigerator isn't working, look into repairing it and then making payments to a refrigerator fund to buy a new refrigerator.

Look for ways to enjoy the simple pleasures. A trip to a local museum (usually with low admission) before or after a great meal at home or a picnic can replace a trip to an expensive amusement park with meals out if you are strapped.

Start planning for better times. As you wean yourself from the borrowing habit and begin to get in a better cash position, start setting financial goals and look forward to meeting them.

Borrowing is a tempting way to garner what looks like a better life. The joy of the expensive meal you can't afford for cash is long gone when the credit card bill comes. How much will you enjoy your new car or furniture if you shake every time you go out to get the mail?

Rather than borrowing, it makes more sense to live within your means, become a saver and investor, and only finance items that will add value to your life after careful thinking and research.

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Copyright © 2001 by Larry Wiener. All rights reserved.

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