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book excerpt

Before you decide to borrow, ask yourself these five questions Add to ...

The following excerpt is reprinted, with permission of the publisher, from How to Speak Money . Copyright (c) 2012 by Ali Velshi and Christine Romans. Excerpted with permission of the publisher John Wiley & Sons. All rights reserved.

Getting Out of Debt

You might think that from what we’ve just discussed, we’d be telling you to avoid debt at all costs. But the truth is that debt can be a good thing. Take a mortgage, for example—it allows you to live in your home even though you can’t afford to pay for it all at once. Or consider student loans. They let you get an education that is likely to lead to a more financially rewarding career than you could otherwise obtain. When amortized over the length of your working life, the money you borrowed to pay for college is likely to be one of the best investments you ever made.

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So when it comes to debt, we’re not in favor of total abstinence. We’re in favor of sensible, practical borrowing for particular situations, consistent with your goals and your finances.

Before you decide to borrow, ask yourself these questions:

• Why are you taking on the debt?

• Is it for something you truly need or will it make your life significantly better?

• Can you get what you want without the debt or without inflicting undue hardship on you and your family?

• Will borrowing restrict your ability to maneuver financially in the future?

• How much debt can you handle without jeopardizing your financial security?

If you give these questions serious thought, you’ll be able to tell when it pays to borrow and when it doesn’t.

If you decide to borrow so you can own a home, fine. But that doesn’t mean you should buy more house than you can afford by taking on more debt than you can manage. Nor should you opt for a mortgage with a teaser rate that could bust your budget when the rate resets.

The same goes for a car. Borrowing to buy a car that makes it easier to commute to work is reasonable. Buying a decked-out mobile home with a loan so huge that the crushing payments force you to forego or skimp on 401(k) contributions—well, that’s a different story.

Of course, in reality, people find all sorts of ways to rationalize questionable borrowing. Sometimes they confuse need with want. We may want that new 70-inch LED LCD TV. But that doesn’t mean we really need it.

Or they justify borrowing on investment grounds. A few years ago when it seemed home prices were going only up, many people borrowed against their home equity so they could invest the loan proceeds. There’s a name for this practice. It’s called gambling.

Sometimes deals seem so good that people don’t even realize they’re headed for trouble. That’s often the case with credit cards, with which a combination of easy borrowing, teaser rates, and low minimum payments makes it shockingly easy for people to suddenly fi nd themselves in deep water.

Still, that doesn’t mean that we should avoid all debt at all times. A more rational response is to be prudent about evaluating when to take on debt.

The one time when people should seriously consider ridding themselves of debt is when they’re in or entering retirement.

Without a regular paycheck, without the opportunity for income to grow, it’s much harder to manage debt—and it’s easier to get overwhelmed by it. But even in retirement there may be times when debt could be helpful. If someone is struggling but has substantial home equity, for example, a reverse mortgage may be a way to improve one’s standard of living.

So here’s an area where we agree: We both recommend taking a nuanced view that recognizes that debt can be good, bad, or something in between, depending on the situation and how carefully you handle it.

How to Speak Money’s Words to the Wise

1. Debt (det): On the plus side, debt allows us to benefit from items we don’t yet fully own, from our homes to our cars, to—on occasion—stocks and bonds. Concepts such as borrowing, lending, credit, interest payments, and the like provide us with the means to improve our lives before we could otherwise do so. On the other hand, some people become addicted to debt and accumulate much more than they can repay. They forfeit their ability to build a future as they become seduced by the now. Debt is a complex and nuanced topic, and it deserves your careful study.

2. Budget (buh’•jit): The easiest way to control your spending and map your future. Everybody says they want complete freedom, but it’s not really true. Most of us, in some aspects of our lives, would prefer to be told what to do. When you develop a budget, you’re telling yourself what to do: the best of both worlds. Following a plan and tracking achievements strokes the side of us that enjoys order and secure progress. And, budgets really work.

3. Software (saw’•fwair): It’s so much easier to set up and track a budget than it used to be. Software programs—Moneydance, Quicken, and YNAB, among others — offer easy-to-use features that make budgeting simple and, at the same time, provide highly detailed information. Many of these programs have apps that work on smartphones and iPads.

 

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