Not Enough Debt, Am I Doing It Wrong?

[MarkOnline]

I was brought up in an era where debt was, on the whole, seen as a negative "Out of debt, out of danger"mentality.
As such we have concentrated on keeping our debt position to a minimum, we have used asset finance for example but always a maximum of 3 years, the last time we financed machines we paid the finance over 6 months. but we could have extended that to 48 months if we had wanted.

We use our own money and have never had a conversation with our bank about other forms of borrowing (I wonder if our bank know we exist sometimes as everything is done online)
Reading recent posts I have started to wonder whether we are not using enough leverage and "missing out" on growth oportunities and oportunity cost by taking our time to grow within our own financial means.

Had a meeting with the M&A partner of our accountants, he wanted to introduce us to lenders in order to help us expand (thats good of him, but thats a different story) but I dissmissed that advice as a "non option"

How do others see the use of "good" debt, do you borrow whatever you are able? I feel that my attitude mat be outdated and in the long term may limit oportunty potential.

 

[Mark T Jones]

It's entirely down to personal choice and aspirations.

Interestingly, lots of people who claim not to have debt actually do have a mortgage (sometimes multiple mortgages) because they believe that's different.

I did create an analogy around debt and alcohol, where some people lead happy & fulfilled lives without alcohol, others enjoy it wisely and it adds enjoyment whilst others become adicted and it causes lots of problems. The analogy falls apart a bit though.

Simply - it's all about opportunity cost - and you have to be the person to evaluate the opportunity to undestand the true cost/value of debt.

 

[MBE2017]

I think you need to decide OP what is good debt, and what is bad debt.

For myself, I consider mortgages(until recently), student loans, and investment money where I am certain as best I can be of a return as good debt.

Debt, just for buying trainers, mobile phones, cars etc when you cannot truly justify or afford them I personally consider bad debt.

Now the banks are offering 40/60 year type mortgages, I am not keen on, since I consider the length of term too long from my perspective, others might have no problem with it.

 

[MarkOnline]

It's entirely down to personal choice and aspirations.

Interestingly, lots of people who claim not to have debt actually do have a mortgage (sometimes multiple mortgages) because they believe that's different.

I did create an analogy around debt and alcohol, where some people lead happy & fulfilled lives without alcohol, others enjoy it wisely and it adds enjoyment whilst others become adicted and it causes lots of problems. The analogy falls apart a bit though.

Simply - it's all about opportunity cost - and you have to be the person to evaluate the opportunity to undestand the true cost/value of debt.

I am talking about the business (LTD co) it doesnt own property it has other stuff though, last few pieces of machinery just paid for out right. We dont use supplier credit we pay pro forma as we feel we may as well pay for it now rather than in 30 days time.(we know where we stand and its how we paid for supplies when we started.)

Dont really count mortgage as that is a cost of living and house price rises keep taking care of the equity side and the payments are negligible. We like to live beneath our means, however I did live in a van for a few months once over (which may have some bearing on my mindset)

 

[MarkOnline]

I think you need to decide OP what is good debt, and what is bad debt.

For myself, I consider mortgages(until recently), student loans, and investment money where I am certain as best I can be of a return as good debt.

Debt, just for buying trainers, mobile phones, cars etc when you cannot truly justify or afford them I personally consider bad debt.

Now the banks are offering 40/60 year type mortgages, I am not keen on, since I consider the length of term too long from my perspective, others might have no problem with it.

Good debt is debt which provides me with an asset which produces free cash on a regular basis I dont count a mortgage as good or bad debt its just a cost of living. I have no issue with a long term mortgage either as I dont value my house as the main storage of wealth. I dont use consumer credit at all.

A acquaintance of mine no longer uses his own companies funds for working capital (car dealer) prefering to be entirely funded by bank and other trade specific lenders.

 

[Mark T Jones]

I am talking about the business (LTD co) it doesnt own property it has other stuff though, last few pieces of machinery just paid for out right. We dont use supplier credit we pay pro forma as we feel we may as well pay for it now rather than in 30 days time.(we know where we stand and its how we paid for supplies when we started.)

Dont really count mortgage as that is a cost of living and house price rises keep taking care of the equity side and the payments are negligible. We like to live beneath our means, however I did live in a van for a few months once over (which may have some bearing on my mindset)

Irrespective of whether it's personal or business, the value of debt lies in the return from its application.

i stopped promoting unsecured loans some years ago, becuse they were attractive to the type of business owner who has convinced themself that throwing money into random, unfocused 'marketing campaigns' was a good idea.

I now only deal where there is a clear, researched underlying plan/project to provide a return.

 

[MBE2017]

I dont count a mortgage as good or bad debt its just a cost of living. I have no issue with a long term mortgage either as I dont value my house as the main storage of wealth.

Nice position to be in, for most people their home is their major asset, with good returns over the years. I know several paper millionaires who have their wealth from their first house buy, some now owning multiple properties.

All a matter of perspective, I am buying my two daughters a home each to save them getting mortgages, I certainly wouldn’t want to see them locked into a 35/40 year commitment.

Apparently I am told the banks are now pushing family mortgages, to allow two or more generations to live under one roof. No idea how it works since I only heard about it recently and have no interest in such a vehicle myself. It took me 25 years to get shot of them, I don’t want them back permanently for another 25 years, the odd visit suits myself fine.

 

[Awinner2]

I have recently used interest free consumer debt to purchase a new vaccum cleaner. I could have just paid on order but the seller offered this option. Interest free over 3 months. In 5 days time final payment will be paid. I understand that there are many companies using this method in their sales system, rather than the catalogue type credit system charging 28% if the balance not paid in full. Obviously, the seller is being charged by the finance company but as the consumer why should that worry me?

 

[Financial-Modeller]

There is nothing wrong with using debt when:

• repayment terms are affordable; even if things change adversely, and
• return on capital borrowed comfortably exceeds the cost of borrowing the capital

There can be lots wrong with using debt when those conditions are not met

 

[MarkOnline]

There is nothing wrong with using debt when:

• repayment terms are affordable; even if things change adversely, and
• return on capital borrowed comfortably exceeds the cost of borrowing the capital

There can be lots wrong with using debt when those conditions are not met

I have tended to use asset finance (for example) when I have had the cash to buy outright but wanted to keep liquidity (I obsess with this liquidity thing) I just think that I may be overcautious. I also realise that I am not bullet proof and spending money (borrowed or otherwise) is no guarantee of success either.

 

[neilsolaris]

I learnt about this very subject when I was studying financial management for ACCA. Here's an interesting link.

https://www.accaglobal.com/uk/en/st...nical-articles/optimum-capital-structure.html

 

[MarkOnline]

What a great link, I shall have to read it several times to understand it fully, but thankyou.

 

[neilsolaris]

You're very welcome. I don't know how relevant it is for your business, but it's very interesting nevertheless.

 

[Mark T Jones]

I have tended to use asset finance (for example) when I have had the cash to buy outright but wanted to keep liquidity (I obsess with this liquidity thing) I just think that I may be overcautious. I also realise that I am not bullet proof and spending money (borrowed or otherwise) is no guarantee of success either.

The crux is the order of events - and the purpose should always preceed the borrowing decision

The worst decisions are made around the notion of 'I can get my hands on £xxx, what should I do with it?"

 

[Mr D]

To me a BBL is a good debt, a payday loan a bad debt. Either one can be useful for a particular need.
But as you say Mark just because we can get some money - does not mean it is a good idea.

My old business had considerable limits on accounts with suppliers. If I wanted to I could have got £100k of goods delivered in a month, and probably a bit more with some sweet talking of directors.
Would have been an incredibly bad idea to max out that way but was possible.

 

[MarkOnline]

You're very welcome. I don't know how relevant it is for your business, but it's very interesting nevertheless.

It puts debt into perspective, I appreciate it is aimed at listed companies but the same principles apply. If I look at debt as a tool for adding more revenue and thus gross profit then as long as I stay within safe parameters its efficient (as other posters have already said).

 

[AllUpHere]

It's a tool at your disposal just like any other. If you can use it to make money, do it. If it's going to be a liability, don't do it.

Whether or not it's a good idea depends almost entirely on the business and it's aims.

 

[Paul Norman]

I don't think you are doing it wrong.

Personally, I would rather tend to err on your side of the sea saw, and be under geared. Maybe not geared at all.

At the same time, I would certainly use finance to leverage an opportunity, should it be one where I believed I could get a decent return.

However, whereas I am willing to take a fair risk with my own capital, getting into debt on a risky project is not my thing

 

[MarkOnline]

I don't think you are doing it wrong.

Personally, I would rather tend to err on your side of the sea saw, and be under geared. Maybe not geared at all.

At the same time, I would certainly use finance to leverage an opportunity, should it be one where I believed I could get a decent return.

However, whereas I am willing to take a fair risk with my own capital, getting into debt on a risky project is not my thing

I tend to agree, risk is for our own funds, not someone elses. I think I need to be less concerned about debt as a tool though. Debt is for doing what we already know (a bit sooner) on a bigger scale I think.

 

[MarkOnline]

Thinking about this a bit more (after reading the link a couple of times) Debt can also be used to leverage time and I think time is undervalued (or the lack of it)
eg I could start a business from scratch and reach £500 k of T/O after 3 years or I could buy £500k of T/O for £100k (nett profit of £40k for arguments sake) If I put in £50k to buy it and borrowed £50 k then there must be less risk than investing £50k to start it from scratch and building it over 3 years. The debt has given me time back that I lose in building a business for less initial cost (or similar cost without the added debt element)
So after 3 years I have accumulated £1.5 mill T/O as opposed to say £800k and it has still virtually no debt as loan has been repaid or substantialy reduced depending on the terms.
My example is based on recreating a business I already know using past realistic timescales.

 

[JEREMY HAWKE]

Nobody on here was saying that debt is a good thing when the banks were pulling their business overdrafts without warning in 2008 many businesses went to wall in an afternoon .
I remember the Mastrict treaty debarkle when Majors government put the borrowing rate up to 18 % and all the businesses here in Cullompton were panicking (no internet then )

I dont like borrowing it is good for sound investments but it is something I avoid

 

[The Byre]

I think time is undervalued

Time is all you have. We all get time. What you do with your time is your affair - but each one of us gets an unspecified amount of time and it's up to us to make the most of it for ourselves and those around us.

Debt? There is no such thing as good debt or bad debt. There is appropriate debt and inappropriate debt. A payday loan is inappropriate. Carrying debt to minimise your tax burden is appropriate. Using a certain amount of manageable debt in order to grow is probably appropriate.

How much and at what rate? Nobody knows! To answer that, I would have to know what interest rates and the various types of inflation (asset price inflation, CPI, money supply, etc.) are going to do in the future. Nobody can predict the future and only a fool says that they can! But if you buy a building at 4% p.a. and inflation is 8% then the mortgage is probably worth more than the building!

So how can we decide what to do? All we can do is manage the various risk factors and probabilities. One thing is certain however, high interest rates would bankrupt any UK or US government, so the BoE and the Fed will move heaven and earth to avoid that! What they want to do is probably to inflate government debt away and keep interest rates low. And the old saying on Wall Street is "Nobody ever got rich betting against the Fed!"

Which type of debt? @JEREMY HAWKE makes an important point - unsecured debt that the bank can pull in times of an emergency is a dangerous beastie! A low-interest mortgage is far less dangerous. We could be heading into a major economic crisis at some time in the next few years and I would not like to be beholden to the banks at a time like that. That would be like being tied to a drowning elephant when you are trying to survive as best you can yourself!

 

[Mr D]

Thinking about this a bit more (after reading the link a couple of times) Debt can also be used to leverage time and I think time is undervalued (or the lack of it)
eg I could start a business from scratch and reach £500 k of T/O after 3 years or I could buy £500k of T/O for £100k (nett profit of £40k for arguments sake) If I put in £50k to buy it and borrowed £50 k then there must be less risk than investing £50k to start it from scratch and building it over 3 years. The debt has given me time back that I lose in building a business for less initial cost (or similar cost without the added debt element)
So after 3 years I have accumulated £1.5 mill T/O as opposed to say £800k and it has still virtually no debt as loan has been repaid or substantialy reduced depending on the terms.
My example is based on recreating a business I already know using past realistic timescales.

That can and does work - but starts you off with a millstone around your neck (the loan repayments) that are costs that must be met. A bad few months, sales not as expected, and the business is far more at risk.

You and I both know what we are doing in our own fields so for us its less of a risk. We know how to spend it to boost the business enough to cover it. Its a risk but far more manageable.
For people new to business, or new to a particular product type, its far more risky.

 

[MarkOnline]

Nobody on here was saying that debt is a good thing when the banks were pulling their business overdrafts without warning in 2008 many businesses went to wall in an afternoon .
I remember the Mastrict treaty debarkle when Majors government put the borrowing rate up to 18 % and all the businesses here in Cullompton were panicking (no internet then )

I dont like borrowing it is good for sound investments but it is something I avoid

But interest rates are less than 6% (thats 5.5% over base) 18% is one hell of a lot of interest to pay if rates move to those levels then anyone with variable rate debt is finished IMO. If you are prepared to pay those rates then you need the debt which is different to choice.

But you are right, things change when you rely on the "kindness" of strangers.

 

[MarkOnline]

Time is all you have. We all get time. What you do with your time is your affair - but each one of us gets an unspecified amount of time and it's up to us to make the most of it for ourselves and those around us.


How much and at what rate? Nobody knows! To answer that, I would have to know what interest rates and the various types of inflation (asset price inflation, CPI, money supply, etc.) are going to do in the future. Nobody can predict the future and only a fool says that they can! But if you buy a building at 4% p.a. and inflation is 8% then the mortgage is probably worth more than the building!

Could you explain that last bit, I dont quite understand what you mean, thanks

 

[The Byre]

Could you explain that last bit, I dont quite understand what you mean, thanks

At 8% inflation, the £300k house is valued in future pounds to be worth £720,000 at the end of a 30 year mortgage.

At 4% fixed interest, the borrower pays a total of £515,000 - but he or she makes those payments in future pounds that are less valuable and therefore easier to part with! At 8% inflation (inc. asset price inflation - the one governments don't like to mention!) every year the pound if worth 8% less than the year before.

At 8% inflation, after 17 years a 'tomorrow' pound is worth half of a 'today' pound. After 25 years it is worth about one-third of a 'Today' pound and almost one-quarter after 30 years.

A pound in 17 year's time is twice as easy to earn and twice as easy to part with as a 'today' pound!

My point being, if you think that interest rates and inflation are going to go up, you make different choices about debt than if you think that they will stay at an all-time low (or maybe even go below zero!)

So what is the most likely outcome for house prices? My guess is that (because they are at an all-time high, even when adjusting for inflation) they will remain nominally static, but fall in real value when adjusting for inflation.