To Borrow or Not to Borrow?
People use debt to finance any number of purchases, and borrowing money
for a worthwhile purchase is not always a bad idea. However, some buys are
worth financing over time and others are not. The Iowa Society of Certified
Public Accountants explains how to make the right choice.
Consider the Costs
The most important thing to remember when going into debt is that you are
paying for the privilege of borrowing that money over time. A bank,
department store, or finance company will charge you interest, which you
have to pay in addition to your repayment of the basic loan amount. And that
interest charge can be pretty hefty, particularly if you only pay the
minimum payment each month. For example, say you buy a $1,000 television
with a credit card that charges 18% interest and you pay only a minimum $10
balance on every bill. Not only will it take you 10 years, or 120 payments,
to get rid of that debt, it will also cost you $799 in interest. In other
words, the amount of interest you are paying could nearly buy you another
TV. Let’s say you paid more than the minimum each month, and instead sent in
$75. In that case, it would take you 15 months to pay off the balance, at an
interest charge of $124. That’s a much lower interest rate, but it’s still
money you could have put to better use elsewhere. With a small discretionary
purchase like a new TV–something you don’t really need–always consider
whether the interest charges are worth it or whether it would be better to
save your money for a few months and buy the item for cash when you have it.
In most cases, you’ll probably find that spending cash is the best answer.
Evaluate the Benefits
Sometimes borrowing may be a good idea, such as when the value of what
you’re buying is likely to rise over time. The best example, of course, is a
home purchase. Although the real estate market has been in turmoil in recent
months, if you plan to own a home for more than five years, there’s usually
a good chance that the property will maintain or increase its value,
depending on many factors that should be considered when you make a
purchase, such as location and the condition of the home. There are usually
tax advantages to home ownership, such as the opportunity to deduct mortgage
interest charges and state and local taxes on your federal tax return. There
are also costs to home ownership, of course, including property taxes and
maintenance expenses. But what sets home ownership apart is the chance to
benefit from the appreciation in the property’s value over time. For that
reason, a carefully considered and affordable home purchase probably is
worth borrowing for.
Look to the Long Term
Financing your education is also considered a valid reason for going into
debt, but even in this situation it’s important to analyze the pros and
cons. For example, you may be able to get a quality education and good
career prospects at a public university, and save yourself the high price of
a famous private school. If you’re thinking of going to graduate school,
take a realistic look at how much the move will benefit your career over
time before you ante up the tuition costs and lose out on potential earnings
while you’re in school. Education is usually a great investment, and one
worth borrowing to finance, but be sure you’re making the best use of your
money.
Consult Your CPA
There are risks and rewards when you borrow money and your local CPA can
help you to understand them. Turn to him or her with any questions you may
have about important financial decisions. If you are looking for a CPA, go to
www.findanIowaCPA.com.
