Debt is bad. Loans are bad. That’s what we are fed religiously on various social media channels as well. That’s correct to an extent too, especially for personal balance sheets. If debt is not managed well, it will lead to big problems. However, things are not always black and white. Debt, if taken within limits and managed responsibly, can be quite useful.
Loans can be useful not just in acquiring assets or experiences, that would have taken much longer if you relied only on your own funds, but also in maintaining investment discipline.
A classic example is a home loan. Most house buyers take a home loan to purchase a house and then repay the home loan over the next 5-30 years.
Yes, home loans do not come free. You must pay interest on the amount borrowed. And if your home loan continues for a long period, the interest component may far exceed the principal repayment. Let’s consider an example. You take a home loan of Rs 50 lacs at 9% p.a. for 20 years. Assuming the rate of interest does not change for the next 20 years, and you do not make any prepayment, you will pay Rs 1.07 crores to repay the loan in 20 years. Rs 50 lacs of principal and Rs 57 lacs in interest.
What Do You Get in Return?
- You do not have to pay rent. That covers the interest cost to some extent. EMIs will remain constant (or thereabouts) while the rents tend to increase over time, especially in big cities.
- You get to own a place and build memories. Your family gets emotional comfort and financial security.
- You get to benefit from the potential increase in the market value of residential property.
I am not advocating that you must go and take a home loan to buy a house first thing tomorrow morning. The answers to such questions are never that objective. If your desired house requires you to borrow beyond your repayment ability or compromises your ability to invest for other goals, you may be buying the house too soon. Or if you think you may have to relocate to another city or country, you may want to think again before buying the house.
Consider another type of loan. A car loan. You may not have the resources to buy a car outright. However, you may have old parents who require frequent visits to hospital OR you may live in a city with unsafe or almost non-existent public transport (which is the case with most cities in India). What would you do? Wait for 3 years to accumulate funds to buy the car outright OR take a loan to buy the car and get that freedom and sense of comfort?
Again, I am not saying that you should buy a car using a car loan or stretch your car budget simply because you have access to a loan. In fact, that’s where you must associate “responsible borrowing” with debt. If you are irresponsible with debt, you will only invite trouble. At the same time, do not always look for such answers (about whether to borrow) on an excel sheet.
Loans Can Be Useful in Managing Investment Discipline Too
To achieve your financial goals, you must invest with discipline. A good way of forging investment discipline is to invest by way of SIPs.
Let’s consider a scenario. Your laptop conks off and you need to buy a laptop worth Rs 50,000. Your monthly expenses and investment SIP do not allow you any bandwidth to spend Rs 50,000. But you must buy the laptop. You invest Rs 50,000 per month.
What would you do? You have two options:
- Stop/reduce your SIP for a month OR
- Take a loan and repay this loan over the next few months.
Yes, you must have an emergency fund to tide over such unplanned expenses. However, this is not really an emergency. This is more like an expected yet unplanned expense. Again, you should plan for such untimely expenses as well in your financial planning but you can’t plan for everything in life. There will always be a few things that you must decide on the run.
Coming back, if you stop the SIP, you compromise investment discipline. I am not saying stopping SIP for just one month will affect your long-term portfolio growth. However, there is a way you handle problems or cash crunch. And this won’t be the first and last time you will face this crunch. You stop/pause SIP once and the next time you face cash shortage, you will stop the SIP. That’s where you have a problem.
If you take a loan of Rs 50,000 for 6 months, you can pay back the loan with EMI of Rs 8,700 for 6 months. For short-term loans, the nominal interest burden is not much either.
Not denying that Rs 8,700 is an additional burden. However, given how we tend to manage cashflows, you may be able to pay the EMIs and continue the SIPs for the next 6 months. How? Because when the cash is tight, we also tend to cut down on the expenses.
This is not a sure-shot approach. You may say this is not too different from borrowing to invest but I am sure most of you would relate to this.
Not all debt is bad. If you borrow responsibly, you can make loans work in your favour. Do not just go by what many social media warriors have to say. Many of them bought their own houses on mortgage but advise you never to take a home loan.
The only finite resource in this world is your time. Hence, do not just think about acquiring an asset or buying an experience. Think about “when” too. Do you want to do this now or 10 years hence? And that’s where debt can help. However, as always, be responsible. All debt must be repaid. Do not borrow what you can’t repay without compromising your financial goals.
Related Reading: Good Debt vs. Bad Debt