Without debt, the world economies would slow down dramatically. Debt is the liquidity that makes the world go round and that is why everybody panics when banks run into trouble. Banks are the main providers of debt, and they take on the risk of you not being able to pay back your loan. So do you have to take on debt to finance your lifestyle? For most people it is not possible to go through life without taking on some debt. If you buy a house or a car, going to the bank to provide you with the capital upfront is very common and as long as you can repay the loan via your income, it is all good. It is also beneficial to use debt in your business or investment property transactions due to the tax benefit you can get. Consider the following example:
In the South African tax law, you can deduct any interest paid on debt used to generate an income. So If you buy an apartment and rent it out, the interest on the bond can be deducted from your rental income, lowering your taxable income. If you were to buy the apartment using cash, there would be no interest payment and the rental would be 100% taxable in your hands. If you do your calculations right, you can buy the apartment with the bank’s money, get the tenant to pay the bond, get the capital appreciation on the apartment and get whatever return you can make on investing the cash you would have used if you bought the apartment for cash.
There is, however, also bad debt. If you borrow money to buy shares, you take the risk of the price of the shares going down due to their volatile nature and having to sell at a loss to cover the debt. There is, however, a case to be made for borrowing money against a share portfolio in some instances. You will notice that there is a lot of chatter about very rich people not paying any tax. The reason for this is the fact that some of them do not earn a salary and get paid in stock options. If the shares they own are worth a lot, they can go to the bank and borrow money against the shares to pay for their lifestyle. If they never sell the shares they will never pay capital gains tax and because they don’t earn a salary they have no income tax. This can go on for a long time.
It is also not wise to incur expensive debt like credit card overdraft facilities to pay for your lifestyle. Your overdraft rate is usually prime plus a percentage, where a mortgage rate is usually prime or even prime less a percentage, but the more negative aspect of going into overdraft is the fact that you spend more than you earn. Living above your means is a slow cancer that can destroy your finances over time.