Good Loans/Bad Loans
The other day I’m driving home in the car and an ad comes on the radio telling me how easy it would be for me to get a home equity loan. The ad further went on to tell me how I could use this extra cash for those needed home improvements, paying down credit card debt, or that great vacation I’ve been longing for. I was dumbstruck, yea it’s an ad and the entire point is to get you to purchase the loan, but still, taking out a home equity loan for a vacation! That’s just several flavors of stupid.
It occurs to me that people may not know when taking out a loan is a good idea, and when it a bad plan. The short answer is that loans in general are almost always bad, if you are not a business, or you are not purchasing an asset that will throw off more cash than the cost of the loan then don’t take out the loan.
Don’t take out a loan and then spend the money on services or something that you won’t be able to sell for more than you paid for it. So vacations are right out, cars and most consumer goods are out as well. A home loan is okay, but you want to put at least 10% down and 20% is better. Student loans for college are okay as they will allow you to increase your earnings over your lifetime much more than the cost of borrowing the money. But be smart don’t use a college loan to get a degree in underwater basket weaving, as that’s probably not going to add to your future earning potential.
The only loan I’ve had in the last 10 years is my home mortgage, but I did refinance and take cash out a few years ago to put that 4.8% money back to work in the stock market. This is an example of taking a loan to buy an asset that will earn more than the carrying cost of the loan. That’s leverage, and a little bit of leverage is a good thing, though too much can hurt much more than it will help.
Good rule of thumb from old Mr Franklin, “Neither a lender nor a borrower be”.