Understanding debt

by Admin
Updated: May 20, 2019

Understanding debt is important for personal development as well as success in business

Many people have an irrational fear of all kinds of debt. But debt is necessary, both as a concept for explaining ongoing transactions and as a mechanism to enable commerce to function.

Debt is the term used to describe something owed. The person (individual or legal person, such as a business) who owes is called the debtor and the person to whom it is owed is called the creditor.

Debt from nothing

Debt can be created from nothing: If you & I each have $20 and I borrow your $20 (e.g. for a month), I now have $40 but I also have $20 of debt. If you borrow back the $20 back (e.g. for one day during the month of my loan) we seem to be where we started, each with $20, but we have also created $40 of debt.

Separation of assets and debt

If you own a building worth $1 million which you purchased with a $1 million loan you could say you were a millionaire, broke, or deeply in debt.

Operating debt

If you charge $500 to a credit card or trade credit and have $500 in the bank, you have $500 of debt but no net debt.

Net debt

It might be that you can turn some materials into a more valuable product, but unless you can get the materials first - thereby incurring debt - you can’t even make a start.

This is normal. In a philosophical sense, almost every aspect of our lives involves receiving first (food, shelter, education, training etc.) in order to be productive second.

Net debt arises from two sources:

  1. Lack of net return from spending
  2. Interest/fees from debt

Whether you buy materials to convert into a product or buy food etc. in order to work, it’s essential to earn more than you spend.

All net debt is temporary until it is either paid off or written off.

How debt is good for you

Living with debt is a learning experience and can be advantageous. Debt should only be a concern if its maintenance payments are high relative to income and time.

Provided that current or future income can be expected to cover interest & fees and make the minimum payments, you can comfortably keep the debt.

Example: I took over a small business that had $10k of debt and no assets. I was able to borrow an additional $40k and build the asset base to over four times that. The terms of the loan were so good that it made less financial sense to pay it off than keep it invested in the growth of the business.

It is easier to get loans if you have a track record of properly maintaining debt (never a late payment) than if you’ve never had any debt at all. This is an important aspect of building up a credit history.

Debt can seem scary if its absolute amount is much larger than amounts you’re used to dealing with, but it’s only a feeling.

The richest people I have ever known carried huge amounts of debt.

More info

“Why is There So Much Debt?” at positivemoney.org

“Seven reasons why debt is good for you.” at yourinvestmentpropertymag.com.au

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