When I use the word know, I do not mean with absolute certainty beyond a reasonable doubt know. I mean to know as in having a reasonable certainty based on credible information. Another way to put it would be “borrow only what you have a reasonable certainty based upon credible information that you can repay, which seems awkward. So let’s stick with know in this rule, knowing that we know what it means
The Trouble with Debt
Debt is not ideal. It’s not a prize you get for having achieved a good credit rating. Debt is something to be tolerated in certain situations and only for defined periods of time under rigid guidelines. Dealing with debt is like owning a python. You have to know what you’re doing, always exercising a great deal of caution because if you slack off and lose control, it could strangle you to death.
A Safety Net Reduces Trouble
While it is always better to not have debt, at times it is unavoidable. So just like living with a python, you become masterful at putting safety measures in place. The stronger your safety nets, the less likely it is that you will be harmed by the debt.
When I refer to safety nets, I mean the guidelines and precautionary measures that are part of Rule 7. Those who throw caution to the wind, venturing into the world of consumer debt without safety nets in place (I include myself in those I am about to call foolish), have lots of scars to show for their foolishness. And it is not only the horrendous amounts of wasted money but also the myriad lost opportunities.
Three Categories of Debt
All debt falls into one of three categories: reasonable, toxic, and neutral. Reasonable, or good debt, is the result of borrowing money to buy something that has a high likelihood of increasing in value, and in so doing will increase your net worth. Buying a home with a low-risk mortgage would be an example of reasonable debt because as the debt is repaid and the home appreciates in value, your net worth will increase proportionately.
Safe Borrowing Guidelines
Borrow the least you can get by with to achieve your intended result, not the most that the lender will approve. Never let a lender determine how much you should borrow. Mortgage lenders will try to nudge you into the most house you can qualify for, not the house you can afford.
Repay debt quickly, rather than stretching it out as far as possible. Opt for the largest payment you can handle, not the smallest the lender will approve. Auto lenders will try to steer you into a long-term loan of 60 to 72 months, pointing out that your payment will be smaller. This is great for them because dragging it out over a longer period of time with smaller monthly payments means you’ll be paying a lot more interest over the term of the loan. That adds up to a big payout for the lender, but it’s a lousy deal for you.