Is all debt bad?

Is all debt bad? To answer that question, we need to consider two concepts:

  • What is the cost of debt?
  • What is the reward to be gained as a result of that debt?

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If you are prepared to enter into debt to purchase a pair of shoes valued at R10 000, the reward will be that you are the envy of many of your friends. Is this reward worth R10 000, plus interest on the debt?

In this example, it is clear to see that the debt is bad as the costs outweigh the rewards.

Maybe you’ll be surprised to hear it, but in some cases, certain forms of debt are considered to be good debt.

For example, imagine you live in a rented property which costs you R10 000 pm in rental. After a year, you would have paid a sum total of R120 000, and would have very little to show, other than being dry and safe in your home.

Had you purchased a house instead, the cost of repayment of your home loan could have been  roughly R180 000 for the year. On the surface, it would appear that you have paid more, but your house would have escalated in value; probably by more than R60 000 (actual repayments of R180 000 less rental cost of R120 000). So, by using the bank’s money, you have leveraged your loan and made money.

As another example, I have a client who has two daughters, aged 3 years apart. Early on, my client had realised that her daughters were going to attend Stellenbosch University, so she bought an apartment. Six years later, when my client sold the apartment, the profit was more than the costs of training her daughters at university, and essentially, their education was a freebie.

When contemplating matters of debt, the main question is: Does the reward exceed the cost? 

If putting in a solar geyser does save money, then that is good debt. If adding an extra room to your house or a new carport increases the value, that is good debt.

If you are seeking financial planning services, contact Northwood Financial Services cc and speak to one of our representatives.

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