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Forbes: Debt: How To Help Your Clients Escape It — And Use It

November 9, 2018

Interview with Forbes about debt repayment.

Debt: How To Help Your Clients Escape It — And Use It

The word “debt” conjures up centuries of negative thoughts. From Shakespeare’s “Neither a borrower nor a lender be” to personal finance guru Dave Ramsey’s well-known statement that “The German root word for ‘debt’ is the same as for ‘guilt’” to arguments over the rising national debt, the intrinsic badness of debt has long gone unquestioned.

And, generally speaking, that’s not far off the mark.

“‘Good debt’ is a misnomer,” said Craig Israelsen, an executive-in-residence in the financial planning program at Utah Valley University in Orem, Utah. “No one ever has the goal to be in debt.”

Yet financial professionals should be aware that not all debt is bad. In fact, it can sometimes be used as a tool for building future wealth, and professionals should tell their clients that.

All debt isn’t created equal, Israelsen acknowledged.

“Our attitude toward someone with a $250,000 mortgage is not the same as someone with $250,000 in credit card debt,” he explained. “People happily admit to having a mortgage balance, but they’re ashamed of that kind of credit card debt.”

Good Debt Versus Bad Debt

In contrast with “bad” credit card debt, debt incurred to achieve a goal — such as homeownership, a college or graduate school degree or starting a business — can be considered “good debt” by some. Israelsen noted that another difference between good and bad debt is whether it is closed-end debt, such as a mortgage that will be paid in full, or a revolving, open-ended debt, such as credit card debt.

Israelsen pointed out that even student loan debt — while necessary for some people to achieve their career goals — can be bad debt when someone overborrows or has invested in a degree that may not generate a large-enough income to repay the debt.

“Housing debt is a necessary evil to ownership, particularly in areas with high housing costs where it’s nearly impossible to pay cash for a home,” Israelsen admitted. “You can’t live in a mutual fund.”

Credit card debt can be the most frustrating type of debt, according to Israelsen — especially because sometimes people don’t even remember what they bought that generated the balance.

But — financial professionals take heed — even credit card debt can sometimes be “good” debt, according to Simon Blanchard, an associate professor of marketing at Georgetown University’s McDonough School of Business, who leveraged a dozen credit cards for rewards points and bonus miles to fund his recent honeymoon to Sri Lanka and the Maldives.

“If you have good self-control and can manage your spending, you can take advantage of credit card rewards programs,” Blanchard explained. “There’s no risk involved as long as you manage your repayment.”

Debt And Life Stages

When people are in their 20s and 30s, Blanchard said, there’s a lot of pressure to pay down student loan and credit card debt. While eliminating debt is a worthy goal, he has noticed that young people sometimes focus on paying off their debt to the detriment of having savings and liquid assets for emergencies — or even a down payment on a house. Financial professionals need to be sensitive to specific circumstances.

“In some cases, you’re better off continuing to pay your student loan debt, especially at a low interest rate, if that means you can save for a down payment on a house,” noted Blanchard. “A bigger down payment can get you a lower interest rate and eliminate private mortgage insurance, both of which could be more beneficial than paying off your student loans a year or two faster.”

It’s best for those approaching retirement age to aim toward little to no debt, Israelsen advised.

“The need to get out of debt implies you have debt,” he said. “But the American dream of getting an education, owning a car and owning a house is built on the idea of borrowing money. The idea is to reduce or eliminate those debts before you stop working.”

The Psychology Of Debt Elimination

Financial professionals should talk to clients about the variety of existent strategies that take psychology as well as money management into account and that clients can employ to pay off debt.

“Objectively, we know that you’ll pay less in interest if you focus on paying off the debt with the highest interest rate,” said Blanchard. “But when people have multiple debts to repay, our research finds that focusing on paying off the smaller debt first results in faster overall repayment. Paying off an entire debt, even when it’s small, helps people judge their progress and gives them a greater overall sense of financial well-being.”

Blanchard added that the role of financial advisers in motivating people to repay debt is as important as it is in helping them find a way to budget for repayment.

“Our recent research found that, on average, people who are motivated to repay debt by a perception that they’re making progress get out of debt 15 percent faster than those who don’t see as much measurable progress,” Blanchard said. “Motivated people work harder at spending less money or generating more income to make more payments on their debt.”

Financial Strategies To Leverage Debt

According to Blanchard, taking out debt to invest in a business can be a wise choice — depending on how much you know about that business.

“You need to understand the risks of borrowing and recognize that the upside isn’t guaranteed,” he added.

In Blanchard’s view, going into debt to invest in the market can be risky, because it’s hard to beat the cost of the debt with profits from the investment.

“The debt repayment is guaranteed, but the return isn’t,” he explained. “For instance, if you’re thinking of borrowing against your home with a home equity line of credit, you’re repaying that at 5 percent. It’s hard to beat that rate with returns, and you’re also placing risk on your house.”

Whatever your clients’ goals, Israelsen recommends trying to help them minimize the amount of debt they incur and approaching any potential debt from a holistic perspective.

“Debt is an instrument, not inherently good or bad,” he concluded. “You can be wise with debt, or you can become a prisoner to it.”


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