Inflation has made Poor Richard obsolete - but borrow carefully
With the debt problems of Argentina, Brazil, and Mexico pervading the headlines, the astounding wave of personal bankruptcies in the United States has faded conveniently into the background.Skip to next paragraph
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But figures compiled in Washington by the bankruptcy division of the Administrative Office of the US Courts indicate that personal (nonbusiness) bankruptcy filings between July 1, 1982, and June 30, 1983, totaled 429,868. That's down only marginally from last year's record 449,839.
Such figures may not give a wholly accurate picture of the improper use of mountains of personal debt amassed in the US each year for everything from home buying to Alpine ski vacations. Claire Longden, a certified financial planner and first vice-president at Butcher & Singer, a brokerge firm headquartered in Philadelphia, warns: ''There have been a lot of books out lately telling people it is a clever idea to declare personal bankruptcy. It is actually not a good idea.''
There is clearly a widespread misuse of credit and miscalculation of how much debt a family can handle.
''It is easier today to run into debt than in the past,'' comments Chris Proben, an economist at Data Resources, a consulting firm in Lexington, Mass., ''because most people can qualify for a credit card at least once in their lives.''
Moreover, the government seems to encourage personal debt, since interest payments are for the most part tax deductible. Many people in high tax brackets have become adept at taking advantage of credit opportunities that allow them to reinvest funds at better rates.
This technique - known as arbitraging interest rates in the financial community - is a commonplace profitmaker at financial institutions. On the individual level, it reached its heyday as people borrowed on their insurance policies at 4 percent and 5 percent and reinvested the money in 18 percent money market funds in 1981. Furthermore, the prevalant belief that inflation will reignite - supported by Butcher & Singer's Ms. Longden - encourages people to borrow even more, since they will be able to repay in cheaper dollars.
Says Venita VanCaspel, president of the stock brokerage firm VanCaspel & Co. and author of ''Money Dynamics for the 1980s'': ''Poor Richard said, 'Don't borrow,' but inflation has made his advice obsolete. Inflation rewards those who owe money, not those who pay cash.'' While Ms. VanCaspel warns clients away from using plastic money (''Never charge anything you can't pay for in 30 days''), she is all for borrowing to fund long-term investments.
But the individual must search his own soul to decide how much he can safely borrow. Banks may make credit checks, but they cannot be used as final arbiters of how much debt anyone can handle. John A. Cook, formerly of the Bank of New York and author of ''All You Need to Know About Banks,'' indicates that it is ''very unlikely'' that a bank really knows what you earn. ''An ever-increasing number of banks are simply not bothering to verify what you tell them,'' he claims.
''Credit, in part, is a psychological thing,'' insists Alexandra Armstrong, president of Alexandra Armstrong Advisors, an investment advisory firm in Washington. ''For some people it would be advisable to use credit, but they can't bring themselves to do it because they are a product of a depression family.''
But she says a spate of clients have approached her over the past year or so, saying they had very low mortgages and ''since the stock market is going great, I really want to purchase some more and I refinanced my home.''
Ms. Armstrong says that in such situations, ''You have to sit down and figure out what the monthly payment is going to be, what tax bracket you are in, and therefore what it will cost you in real dollars, and then whether you are putting it into an investment that will bring you offsetting income.'' And when remortgaging, don't forget extra expenses like ''points,'' she adds.
In general, Ms. Armstrong believes, ''If you are going to make an investment that is long term - at least four or five years or longer - remortgaging a house is usually worthwhile.'' However, ''If you are going to do it for short-term needs, it usually isn't.''
But on the whole she recommends a loan on one's home as an advantage, since government tax rules permit deducting all the interest. Interest on loans to purchase investments can be deducted only up to $10,000.
Butcher & Singer's Claire Longden is more hesitant about recommending home financing as a tool for raising cash. ''If you are going to refinance your home at 13 percent,'' she says, ''you have to make sure that what you are going to do with that money is going to give you the right return. If you are borrowing money on your home for your child's education, you are not getting a return on that money - so you could be digging yourself quite a deep hole.''
Instead, she says, ''You could go to your corporation and see if you can borrow against your pension fund. Or you could borrow against your life insurance policy's cash value.'' Or you could put stocks on margin, although ''if the market goes down, they are going to want more money from you.''
But although cautious, she is hardly opposed to using debt:''I am not against mortgages,'' she says. ''You have to leverage money. Otherwise you are just not going to keep up. Inflation is not going to go away.''