Despite the grim reality that Canadians have never been more in debt, borrowing isn't always necessarily a bad thing.
"There are times when it makes sense to borrow," says financial advisor Brett Simpson, chair of Rogers Group Financial.
Ask yourself four questions when it comes to weighing the benefits and drawbacks of borrowing, he suggests.
- Does the borrowing purpose have a reasonable expectation of improving your net worth?
- Does the financing have a lower opportunity cost than other sources of funds?
- Are the financing payments manageable, even in less likely scenarios?
"A lot of people think about the best-case scenario, then they take out a loan and something happens like they lose their job or an investment doesn't pay off or there's a vacancy in their rental property and they haven't really accounted for that. You need to take into account the unexpected."
- Is the loan "naked" or does the purpose of the loan "clothe" it with a corresponding asset?
"Just getting a loan and acquiring nothing for it — that's what I call a naked loan," Simpson says. "Or is it something like a home improvement that will improve an asset or an investment that could always be liquidated to cover the loan?"
With those points in mind, there are several good reasons to borrow money. Consider a few:
Let's face it: Student debt has become a reality for a vast number of Canadians. Nearly 425,000 students borrowed funds in order to finance their education this past year, according to the Canadian Federation of Students.
While an investment in your future may seem crippling when right out of school and faced with dismal employment prospects, it can and should pay off in the long run.
"You can look at education and have a reasonable expectation of it improving your net worth in the future," Simpson says. Plus, you're likely to have more disposable income and more ability to save.
"This would fit into principal number 2 — opportunity costs; if the automobile company is going to provide zero-per cent or low-rate financing, 'Why should I use my money when I can earn a better rate of return?'
And just because you may have the cash to finance a large purchase, doesn't mean you should shy away from credit. "Not only can this improve credit rating, which is important for younger people, but you can use cash more productively. It's not a naked loan in that you've got something to show for it," says Simpson.
Some provinces, including British Columbia and New Brunswick, offer a low-interest loan program that helps homeowners pay annual property taxes on their principal residences. This can be especially appealing to seniors, who might otherwise be withdrawing investments and paying income tax on those in order to pay their property taxes.
"If you're going to do it anyway, it may be better to use the bank's money while it's cheap and do the improvements — you're improving the asset and enjoying it a little bit earlier; not improving it right before you sell it," Simpson says. "The loan isn't naked, and as long as the financing payments are manageable and there's low opportunity cost from the bank, it might make sense. Be sure to structure payments over time."
It doesn't always make sense to borrow to beef up your RRSP contribution, and it certainly doesn't make sense to borrow year after year, Simpson says. But it might make sense to borrow if you need to gain from the income-tax deduction. If you're retiring, taking a sabbatical, taking time off work to be with your kids, or otherwise expecting a drop in income, an RRSP loan is something to think about.
An investment property
Whether it's a rental property or a family cottage, interest on investment property is tax-deductible. Plus, you're building up assets, which feed directly into your net worth.
Just remember, if you borrow for any kind of investment and it flops, you're still accountable for the debt you've incurred.