Going into debt by borrowing money is typically frowned upon; the borrower becomes a slave to the lender. But are there valid reasons for borrowing money? Aren’t there times when it’s appropriate? Read more at Beyond the Ten Percent.
Some would say that to borrow money to make a purchase is an indication that the person is impatient, unwilling to wait out the time to save, and therefore unnecessarily goes into debt to satisfy a desire. Others would say that it is necessary and therefore required to go into debt in order to reap a profit. Are there purchase where each of these statements are true? Well, it all depends on the item that requires the money.
In accounting there is a term for an item over a certain dollar amount and that is an asset. The dollar amount is a guideline that acts as a trigger for capitalization. And capitalization usually triggers a depreciation process that can take years to complete. All this said I want to also suggest that there are two kinds of assets, appreciating and depreciating.
Depreciating assets are those kinds of assets that lose all or most of their value over time through use. For example, a new car loses value the minute you drive it off the car lot. Furniture is designed to be used and therefore is a depreciating asset. And most would agree that these assets lose value over time but they do retain some residual value, even if it’s just scrap value.
Appreciating assets on the other hand increase in value over time, even though they may be used. The prime example here is land (real estate), improved or unimproved. The value of land has proven to be an asset that increases in value, though recently it has demonstrated some extreme volatility associated with unhealthy lending practices.
Larry Burkett (1939-2003) in his financial radio programs would say (in essence): always pay cash for depreciation assets and borrow cautiously for appreciating assets. And this continues proves true.
If you were to buy a car or furniture today, paying cash is still the best way to pay for it. Why? The interest you will pay for the loan increases the effective price you are paying for that asset. Specifically, total purchase price equals the price of item at time of purchase plus financing costs. For example, for a $5000 loan at 5%, you would pay ~$400 over 3 years for that piece of furniture or $5400. And for a depreciating asset, this simply does not make sense to pay more money for something that will decrease in value over time.
Yet, if you purchase a home, it is typically expected that the home would appreciate in value with appropriate upkeep. At the very least, you can expect it to keep pace with the rate of inflation.
But here too, there are lots of variables that determine the value of the home and these can change over time. For example, in the news recently it was reported that oil wells are being installed in adjacent lots causing many to protest that their property values are going to decline – and they probably will. The point here being that the oil well wasn’t there when the home was built and not that it is there, the property value has fallen.
Overall, most will agree that there are no guarantees in life, yet some choices are better than others. Be an informed buyer at all times.
Now you may be asking: Are there other kinds of appreciating assets that I might borrow money for? Yes.
Here are some examples of both:
Appreciating Assets – Land, improved and unimproved (without any buildings on it); College education. Yes, the list is short.
Depreciating Assets – Cars, trucks, boats, snow mobiles, furniture, appliances, vacations (when paid for by credit cards), and electronics. Yes, this list almost seems endless.
Now there are some exceptions in the depreciating asset class that are worth noting. For example, antique furniture can be an appreciating asset or even a classic car. But be careful, there are many who are fooled into believing something is of value only to learn later that the item was a reproduction. And so I recommend you step into this space very cautiously and use this course only as a means of generating a greater return on your money over the current form that it is in.
But are there other assets that could appreciate? Yes, but it is usually in the class that includes lots of speculation. For example, precious metals as used in jewelry and the gems that encrust them have their intrinsic value associated with them (e.g. gold melt value = intrinsic value but the piece value can be much higher due to artistic design). And we know that the precious metals markets rise and fall with time. The bottom line here is jewelry is a luxury item and in my opinion one should always pay cash for these kinds of items.
Lastly, let me suggest that businesses also borrow money to maintain a level of cash flow or for investment into the business and to do this borrowing money is often necessary. But the focus in my blog is personal finance and therefore I will leave this topic for others to comment on.
At the end of the day, you have to ask yourself the following questions:
· Is this an asset that will appreciate or depreciate in value?
· Are you willing to pay that much more for the asset due to financing costs?
· Do you really need the item?
· Is there a way to save as much as you can to reduce financing costs?
· What will the cost of ownership (repairs, insurance, etc.) be for the item? Do you have this in your budget in addition to the financing costs?
· Lastly, have you prayed about the purchase? Does God have an alternative for you to consider, especially when you don’t have the cash for it?
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