You might find my thinking radical, but you must hear this…
I was walking by a local bank yesterday, and I saw an advertisement for consumer loans.
On the ad, a young family was redecorating their apartment according to the latest trends.
I couldn’t help but think to myself: “What a bunch of nonsense.”
The bank was literally advertising a deal with the devil.
“Let us lend you money, and all your dreams will come true.”
And banks are hardly the only ones. I am sure you remember Mastercard’s famous “Priceless” commercials.
“A bouquet of flowers: $30. Dinner for two: $150. A bottle of French Wine: $60. A chance to impress the women of your dreams: Priceless.”
The point is, most people can’t comprehend the long-term obligations of taking a loan. They see how they will satisfy one of their short-term needs, and everything else will work out on its own. Like nothing could possibly go wrong.
And financial institutions are more than willing to exploit this reality. It’s not like they’re known for their ethical behavior.
If it were up to me, I would make all loan advertising illegal. Or at least I’d require it to paint a realistic picture, instead of misguiding consumers with Faustian bargains.
I am a strong believer in living loan-free.
However, there are a few instances when taking a loan makes sense…
1. You’re Buying Something You Can’t Live Without
A loan is always a bad idea if you’re using it to purchase lifestyle products, like a new kitchen or a fancy car.
However, let’s say you live in a cold climate, and you need a working heating system for your house. That’s a basic need that can’t wait until you’ve saved enough funds to cover the cost. In this case, a loan makes sense.
Same goes if you’ve got a leaking roof or if you must drive to work and need a functioning car.
2. You Can Qualify For A Government Loan
Government loans typically offer favorable repayment terms compared with banks, making them more sensible.
Moreover, these loan programs are typically available for things that can improve your standard of living—things like education, home-buying, energy-efficiency retrofitting, and so on.
VA loans, FHA loans, and USDA loans, for example, can help you with buying a home and save you on the up-front costs.
3. Your Interest Payments Are Less Than Your Investment Returns
Typically, people use money from investments for major purchases, rather than considering a loan. While this is the right approach, there are cases when it’s sensible to leave your investment funds alone.
Let’s say you have a portfolio that generates 7% in annual returns… and the opportunity for a loan with an interest rate of only 4%. In this case, it makes sense to leave the portfolio untouched, as liquidating it would mean giving up 3% in portfolio returns. Furthermore, you’d be able to use the portfolio’s dividends to cover the interest payments.
On the other hand, if you’re paying off a high-interest loan, such as from a credit card, then portfolio monies can help you pay it off early.
Be careful, though, not to be tempted to tap into your emergency fund. That’s for real emergencies only, such as health problems or bankruptcy, not for paying off your credit card expenses.