*Borrowing for Life*
Borrowing money is largely a personal preference that scares some and comforts others. If one is not comfortable with borrowing money, they will typically avoid that endeavor. The perspective that I hope to share is that borrowing under the right circumstances is a sound financial decision. Several factors have influence over a decision to borrow. These include inflation, lending rate, intended use of the borrowed funds and future cash flows. Using these factors, any person can borrow money effectively. I am a proponent of buying large assets on borrowed funds, and do not encourage borrowing for perishable items, which include immediately consumed nourishment, vacations, gasoline used in vehicles, items that rapidly depreciate like televisions, and other items that become outdated and worthless in short order. Assets are things that typically last five to 10 years and sometimes more. Examples include decks, roofing, ATVs, wood burning stoves, good quality long guns and pistols, quality tools, generators, and an assortment of other items that if properly maintained should provide long term use. I did not mention vehicles but a multiuse vehicle like a BOV would certainly qualify.
Let’s start with the why; why would one make a decision to borrow money as opposed to saving up and then buying in a debt free transaction. Why would someone with plenty of cash on hand borrow to buy instead of using that cash? To answer these questions we have to ask and answer a few more questions such as what the expected future price of the item will be at the point when if borrowed funds are used, it is paid off. That is if you borrow $5,000 to purchase a generator, and you commit to paying it off in 18 months, what is the expected purchase price going to be in 18 months.
This cannot be answered with absolute certainty, but using past data it can be closely predicted. Inflation, and supply and demand will be the most important variables, and supply and demand are tough predictors. So we look at the expected rate of inflation, that is, how much buying power does a dollar have today compared with some point in the future? The last factor is the net present value of buying versus borrowing. It has to be computed for both scenarios. However, the variable that must be taken into account and the one that is always overlooked by the academic folks is the useful value of the asset during the interim. That is, if I have to wait 18 months to buy a generator, and it is needed during that 18 month period, what value does this represent? This is a very important concept that I want to reiterate; having an asset in inventory and at your disposal holds economic value, and should be a factor in every single analysis.
The problem arises in placing a value on an intangible convenience. What value can be placed on having an asset in your inventory that is at your disposal, as opposed to having to compete for that asset during a time of distress? This is a complicated question, but looking at past data can assist in this analysis. During a time of distress all assets that can be used to continue the process of living and carrying on will immediately be in higher demand. The more assets one has, the more buying power one has for barter and trade. In a national scenario, the value of US currency will be diminished and inventory items like water, ammunition, food, electricity, and other sustaining items will be in high demand and extremely valuable. Some of these would be considered liquid assets that could be easily traded for another item of equal or greater value. Therefore, to place a value on this intangible, think of what you could trade for this item in a natural disaster and what value that item may represent. If during a period of chaos, you could trade a generator for 100 acres of land, the tangible value suddenly becomes very tangible. Or imagine being able to trade water for gasoline. These are certainly possible scenarios.
Let me start with a very simple example. A generator that cost $5,000 now will cost approximately $5,665 in five years if inflation is 2.5% per year. If you buy it now, with cash it will be $5,000, if you must save for five years it will be $5,665. Now let’s look at borrowed funds. Consider that credit cards are only useful if the interest rate is below what a local bank will charge and bear in mind that all credit card companies are banks in one form or another. Credit cards can be useful but one has to be very careful as to how it is used, and most importantly what the effective borrowing rate is when fees and other charges are considered. Look for good deals on credit cards. I’ll discuss this in greater detail later on.
Local banks are typically a good route especially if you can establish a good report with the bank and its staff. When considering a bank, try to use local banks and if you can use a credit union. There fees are much lower, the lending rates are more competitive and I’ve found they are much better to deal with. Most credit unions also allow one to borrow money against a free and clear titled vehicle at very competitive lending rates. As an example, a friend of mine went through a divorce and needed money to hire a lawyer. He owned a 1985 Mercedes 500SEL. The credit union looked at the vehicle and gave him a $7000 loan at 4.75% simple interest for 48 months. This of course was during the low interest rate period and that same rate today is 6.5%. That’s still very competitive.
Most banks will offer unsecured personal loans for about 10% simple interest with no prepayment penalty if you have a good credit rating of 700 or greater. If it takes you 5 years to pay it off, paying $105.35 per month the total cost of the generator plus interest would be $6,321. The future cost of the generator with inflation is $5,665, a difference of $656. However, during this five year period, you’ve had no use of the generator, and that variable must be considered. Considering this in isolation, I might use cash to buy the generator, however, let’s consider a more realistic scenario.
Let’s assume we need a $5,000 generator, a $5,000 solar panel, and $10,000 for fully equipping the house for a SHTF scenario. We need a total of $20,000. Let’s again assume inflation is 2.5% for the next five years and let’s assume we are going to borrow the entire amount, but can’t borrow enough to do it all at once. This requires maximizing your debt and cash flow simultaneously. This calculation requires calculating future cash flows and is at the heart of why borrowing can be a sound decision.
Let’s start with cash flows. The excess cash flows that are expected to be generated by the income producers in the family unit are expected to be $400 per month over the next 5 years. This excess is to be used for survival preparation exclusively and you want to maximize you purchasing power with this $400. Again let’s assume we can borrow at a10% annual interest rate. The total amount of purchasing power this represents over a five year period is $18,983. Simply stated, one can borrow $18,983 for 10% interest over a five year period and pay $400 per month to pay off the debt. This is $1,017 short of your immediate need however, and an alternate strategy needs to be employed. Maximize your debt and use it to buy the items with the highest priority. You know you can pay $400 per month so let’s say you borrow only $15,000 for the solar panel and home conversion and save the difference. If you only borrowed $15,000, your monthly payment would be $252, a difference of $148. It would only take 32 months to save $5000 if putting $148 away per month and if it earned 4.9% interest during that time. If it didn’t earn any interest, it would only take 34 months. Thus your buying power is maximized. If you wanted to save $400 per month for five years without the use of the assets over that time frame, it’s obviously more advantageous from a strictly numbers perspective. However, I believe having certain assets in the present holds a tremendous amount of value, albeit intangible.
One of the most glaring questions is what happens to this debt if the SHTF and I can’t pay it back. The good news is you have the assets, or most of them. The other good news is, if it’s a real bad scenario, or something like Katrina, your debt won’t matter a whole lot. If the Wolf comes knocking, so what. At present there are no debtor’s prisons in the US. Might that change? It’s an unknown.
Now let’s look at opportunities to continue maximizing this debt. We’ve all seen the credit card ads that come in the mail that advertise a 0% interest rate for all balance transfers. Now, they are even waiving the transfer fee. Let me state that I have and will continue to use low interest financing because at some point, it will cease. What most of these credit card companies are hedging on is that most consumers pay late, and thereby voiding the 0% deal. I don’t have the statistics, but I would bet the percentage of late payments is high. However, it you are responsible and pay close attention, these are some of the most lucrative ways to borrow anywhere in the world. For example, I recently received an offer from a bank in Omaha because I’m a member of a certain organization. They offer me, 4.9% on new charges and balance transfers for the life of the debt. This is like borrowing at 2.5% when inflation is considered and I am so glad I took advantage of it. The key is, to pay close attention, and don’t throw away too much junk mail because there might be a legitimate offer that could save you thousands of dollars over the long term.
Another way to take advantage of this system is to borrow at the promotional rate for 12 months while investing the proceeds in an IRA with a higher yield. For example, if you borrow at 2.9% for 12 month and invest at 4.9%, it’s capitalizing on a market out of balance. Of course, over time it will correct, but if the opportunity is there, be responsible and take advantage of it. This is especially true for individuals who have lots of cash on hand and don’t need to borrow to buy, but could borrow to invest.
There are many dangers associated with buying on borrowed funds. First and foremost is an inability to pay back your debt due to unforeseen circumstances. The way to avoid this problem is to stay away from borrowing money. However, a more interesting alternative is to hedge. Hedging is employed all over the world and we even do it in our daily lives everyday. We buy two for one sale items because we expect next week the price will return to normal. We buy more than we need in the event of an emergency. We prepare for a natural disaster so that we might survive, this is hedging and in the financial markets it has the same concept. Some investors will buy stock, and buy rights on the lower end so as to create a stop loss in the event the stock tanks. Many strategies are used to hedge against loss. The most important aspect of it all is planning. That is, plan for losing your job in 6, 12 or 18 months. Go through the scenario and have a plan to sell or borrow against your assets. If you have a plan, and you know how to execute it, no short term job loss or unforeseen expense should create a situation where you aren’t able to meet your debt obligations.
For example, try to stagger your debt load and always have enough free and clear assets to pay your monthly obligations for at least 6 months. Post an ad for some of your assets and list it above fair market value. If you get calls, keep the person’s information so that you might contact them should you need to dispose of the asset. If the person is willing to pay a price above what you think it to be worth, you’ve made a potential profit. Watch the paper for similar assets and make notes regarding market prices. Make a list of all of your assets that could be readily disposed of and calculate a low, average and high price range. Additionally, rank the items by level of importance.
In summary, unsecured, non-recourse debt is the most desirable. If you are okay with taking out a second mortgage, or line of credit against your home, that is also a viable alternative, but the lien is against your property, whereas a credit card, or personal unsecured note are not. Vehicle loans are viable options, as well as promotional low interest rate credit card bills. Sound planning can involve borrowing if done correctly.
JYWolfe
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