Learning to use debt wisely

With interest rates at record low levels many people would view this, as an opportunity to make a major purchase, such as a house or a car. The question then becomes how much debt might be reasonable for one to undertake.

Borrowing money entails risk, whether it is for personal or investment purposes. What determines the level of risk is the percentage that is financed. Someone who finances a home with 25 percent down is in a significantly less risky position than a person who puts down 10 percent or less.

Many people who have been successful in real estate, owning multiple properties, have done so with a high degree of borrowed money. If you put 10 percent down, and the property increases 10 percent in value, your original investment, which is the amount you put down, has doubled.

Unfortunately, this strategy of putting a limited amount of money down has led to many people losing their homes when prices drop. It should be noted that there are many wealthy individuals who have experienced severe financial setbacks, such as bankruptcy, only to regain their financial well being later on. However, most people would generally not be comfortable being on this kind of financial roller coaster.

What is occurring presently is that mortgage-lending standards are being loosened again. This means that more people will be able to purchase homes with a limited down payment. Just because someone may be able to qualify for a loan does not necessarily imply that they should obtain one.

If someone has to use all of their available funds to be able to meet a relatively low down payment, then they are probably not ready to purchase a house. A homeowner should have at least 3 to 6 months of income set aside for possible repairs and/or job loss. In addition someone’s monthly budget should not be so tight that there is no cushion left over after covering one’s necessary expenses.

In obtaining a car loan there are a couple of key differences versus having a home mortgage. A home mortgage is tax deductible to a $1 million, while a car loan is not. In addition purchasing a home is an investment, besides furnishing a place to live. An automobile is not an investment, as it is continually going down in value.

Very low financing rates may entice people to purchase more expensive cars than they should. In addition car loans are getting longer on average, sometimes to six or seven years, in essence leaving someone with a continuous car payment. Having this constant car payment may prevent someone from adequately saving for their retirement.

Oftentimes the low financing rates are in lieu of discounts on the purchase price of a car. Therefore, someone is paying extra for a car, just to get the cheap financing. With that the case, you are probably not getting that good of a deal.

The optimum strategy would be to pay cash for a car. While that might not be feasible for many individuals, especially younger people, someone should strive to have the car loan, be as short as possible. When people do not have a car payment their financial flexibility increases dramatically.

When interest rates are low, it is easier for people to borrow, however people need to be careful not to get overextended. In addition borrowing makes more sense, when it is tax deductible.

When things go wrong, individuals or businesses that have a high degree of borrowing can go bankrupt. For example with oil prices down, some oil producers with limited capital will face financial ruin. Generally speaking it is best not to purchase the most expensive house or car you can qualify for, but keep something extra in reserve.

Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.