Debt: Friend or Foe?

As seen in the February edition of Master Investor Magazine.

As we constantly read and hear, Millennials are tarnished by the presumption that we are a lazy, self-obsessed and entitled generation. Of course, there are always a few who give the rest of us a bad name. But many are not; they have just been given, time and again, unfortunate advice from their baby-boomer parents, who base their supposed knowledge on the social and economic paradigms of 30 years ago, when they were in our shoes. And one of the biggest misconceptions they pass down to us is the idea that all debt should be avoided.

For many Millennials, the word debt has gravely negative connotations when judging how reliable and restrained someone is. But debt is not just for emergency student situations; it is regularly used by wealthy and successful individuals and organisations to expand and advance their market reach. If approached in the right way, debt can help to kick-start success through freeing up cashflow or through capital investments.

Whether you are considering a mortgage, a student loan, or a credit card, not all debt is useful in equal measures, yet it can be necessary if you want to start a business, buy a house, or simply further your career prospects through university. The burdens of debt fluctuate with economic cycles. In an economic downturn, interest rates are lowered to prop-up the economy, so borrowing becomes cheap, although it is also admittedly considerably harder to become accepted for a loan. When the 2008 recession hit, those that were able to borrow could buy properties within Britain when house prices were low, and they borrowed with low interest rates. Given that the banks were offering virtually no interest on any savings accounts, putting your money into property was a sensible option.

The result was that successful landlords were able to remortgage their current properties and use the cash to increase their home ownership elsewhere with even more properties. As the economy has subsequently improved, prices have increased and many of those landlords have ended up on top, with many having sold their properties at a profit just as interest rates start to rise. As rates rise, the hardest part is knowing when to sell to ensure maximum profit, but the mathematics is simple; when you’re earning 100% of the capital gains from every house you sell, owning five, each with an 80% loan to value (LTV) mortgage, will make you considerably more than buying one outright and not having a mortgage on it, just because you’re scared of the debt. With the Bank of England base rate currently at the incredibly low 0.5%, this has set the bench mark for interest rates across various markets, including mortgage rates.

Taking out a mortgage

I generally see mortgages as good debt. They are the key to being a homeowner, and are the one of the cheapest forms of borrowing. Britain has the fortune of not being reliant on oil for its economy which has meant the Sterling has stayed strong whilst other economies have been dragged down along with the oil price. Britain’s economy is currently buoyant and steady. Unless you are one of the lucky few with the bank of Mum and Dad behind you, buying a flat will require a mortgage. For first-time buyers, the interest can be as low as 1.94% with Yorkshire Building Society, based on a 90% LTV tracker. Of course, if the rates go up, your mortgage payments increase with it, but even a fixed mortgage with the Co-operative bank is only 2.14%. Compare that to New York’s 4.75% or Australia’s 4% and you realise that you’re in a good position if you’re buying in Britain. Moreover, considering the situation of oil-reliant countries in South America, such as Brazil, Argentina or Ecuador, all of which have mortgage rates over 20% for first time buyers, we Brits should appreciate the comparatively positive situation we are in compared to other Millennials around the world.

Student debt

Student debt, like a mortgage, is also a cheap form of debt. Yes, you have to pay it back, but by the time you’re paying it back, you’ll be earning over £15,000 GBP so life will already be infinitely better than when you borrowed the money and lived off Pot Noodles for three years at university. As with mortgages, Brits are often unaware just what a fortunate position they are in compared to some of their neighbours. Unless you live in Scotland or Scandinavia, higher education costs money, and usually lots of it. But it’s money well spent if you’re doing a worthwhile qualification. Upon deciding whether to attend university, Millennials are now required to carefully consider the economic benefits before accepting a position. Medics are often worst hit, and leave with £70,000 worth of debt; but that doesn’t mean that they should ignore medicine and go into a blue collar job or the City; it just means they need to make sure they want to be a doctor before starting the course and dropping out. If university debt is your only route to your chosen career path, and either the salary or career fulfilment (or preferably both) will be worth it, then it’s of course an unavoidable hurdle, and no doubt a good one if you are playing the long game. Compared to studying medicine at an Ivy League university in the US, you’re forking out roughly 20% of what Americans need to pay, so things are looking up. Not only do they pay four times more in fees, but they usually train for two years longer, so leaving Stanford with a medical degree will leave you in $400,000 worth of debt, and other universities are even pricier.

Student loans are different to most loans, which you are usually forced to start repaying immediately. You will only be asked for repayment when you are earning £15,000 a year, which means that if you want to go travelling after university for a year, you won’t be chased for repayments until you start a paying job back in the UK, and even then the repayments are set in line with your earnings. Given that interest rates are set at less than 1%, you almost can’t afford not to take on the debt in return for an enhanced career.

Credit card debt

This is the best, worst and most useful kind of debt, all at once. It’s the best debt in that credit cards want to lure you into using their cards, which means that there are plenty of 0% interest cards around, many of which last for 12 months. That equates to a year of borrowing, with not a penny of interest paid. The card will allow you to buy supplies for your business, improve your home, or further your educational studies, so it’s the perfect way to have a free loan which you pay back in full at the end of the 12 months.

Of course, not everyone is restrained and it is easy to become careless with spending, especially if you’re a shopaholic. At the end of the 12 months, interest rates can rocket. American Express cards range from 17-35% per annum, and to make matters worse, they’ll charge you interest on your interest if you don’t pay it off immediately. Spiralling into debt is all too common for consumers who buy without even considering whether they’ll be able to pay off their debts after the honeymoon period of interest-free credit has ended. It’s important to remember that credit-card interest rates are nowhere near as high as ‘pay day’ loans, so they are useful in an emergency, but should be treated with caution.

Whether you use them or not, credit cards are useful for Millennials with very little credit history. UK Mortgage lenders will very rarely approve a loan without some proof of payment history, and credit cards are the perfect way to boost your credit rating if you’ve never had a loan or a mortgage before. Unlike with debit cards, credit cards are tracked, so the more you spend, and the more you pay off on time, the better your rating will be. It shows lenders that you are in control of your finances and that you are accustomed to paying balances on the deadline. Aside from these benefits, credit cards protect your purchases, and many offer perks for spending. For instance, my American Express British Airways card gives me enough air miles for a return flight to Rome every year, just for using the card for day to day food and living purchases.

The key when going into debt is to be aware. Understand your spending, and understand your debt. There are some great options out there, and it is important to realise which are best for your personal situation. For many, a change of mindset might be necessary. Rather than being scared of debt, embrace the right sorts of debt. Using it for significant aspects of your life, like getting on the property ladder, or accessing a higher education course, can be worth the initial fear you might feel. Be aware and keep tracking rates and economic cycles, but don’t avoid it altogether.

So if you’re thinking about applying for that MA, or you are worried about the burden of owing £200,000 of debt to the bank when you buy your own home, remember the positives.  Remember that with debt, you are also in line as a homeowner to gain 100% of capital gains increases when you sell, and that it is usually the only option if you want to get out of the renting trap. Why not take out a loan and go for your dream, rather than wondering how many pennies you’ll earn from this year’s measly ISA contribution? It’s all about getting your foot in the door. Being in debt to the bank may seem daunting, but with interest rates as low as they are, and with the property market still bouyant, debt really shouldn’t be a dirty word.