Most individuals spend considerable time and effort trying to reduce their debts. But sometimes it makes sense to take on some additional debt as a financial planning tool. ''There are times when borrowing is effective'' in expanding individual wealth, notes Marvin P. Pechter, a partner in the Atlanta-based accounting firm Connally, Pechter & Company.
Many Americans' basic debt load comes not as a matter of planning but from sheer necessity. For example a mortgage makes it possible to purchase a home when the full purchase price is not in hand.
But there are several options - which range from purchasing investment property to making more complex, tax-reducing transactions - where borrowing for financial planning purposes can make sense even for individuals who don't have a rock star's income. The methods discussed below should work for individuals with annual incomes in the $25,000 to $50,000 range.
For middle-income individuals, borrowing in order to invest ''may be their only hope'' of coming up with the necessary funds to start an investment program , says Richard Miller, a partner in the certified public accounting firm Peat Marwick Mitchel & Co.
Financial advisers make it clear they do not advocate plunging headlong into debt. And most lenders will not make loans which fund the more ambitious financial-planning maneuvers if individual or family debts already exceed industry norms.
To negotiate a loan, ''personal obligations should not exceed 50 percent of personal'' income, says Roger Conduit, vice-president of Manufacturers Hanover Financial Services, the consumer finance arm of Manufacturers Hanover Trust Company in New York. In totaling personal obligations, Mr. Conduit includes fixed debt payments like mortgages and car loans as well as recurring expenses like utility bills. Personal expenses like food and clothing are not included.
Of course, precise lending limits are tailored to individual circumstances. ''In some cases obligations of 50 percent are too much, in other cases an individual can handle 60 percent,'' he notes. Among the most effective ways of using debt as a financial planning tool are:
* Using debt to purchase investment property. For people who are concerned about inflation, ''borrowing might permit accumulation of some investment real estate of modest proportions, which might appreciate,'' says Leon Nad, a partner at Price Waterhouse, another certified public accounting firm.
''Real estate is the most viable way to create a secure investment and tax writeoff,'' Mr. Pechter adds. He is chairman of an American Institute of Certified Public Accountants task force on personal financial management.
Consider the relatively simple case of a married couple without children. They do not have enough deductions to make it worthwhile to itemize deductions and so claim the standard deduction of $3,400 on their federal taxes. If they reduce their taxable income by $10,000, they can cut their federal tax bill by about $3,700, Mr. Pechter calculates.
One way to proceed would be for the couple to borrow $10,000 to make a down payment on rental property. Again, for the sake of simplicity, it is assumed the rent on the property will just cover their interest expenses and other costs. Such an investment could conceivably generate $10,000 in depreciation. Depreciation is a charge which reduces the taxable income on a property to compensate for an assumed reduction in value as it ages.
Of course, the couple would have to pay interest on the money they borrow. If the funds could be borrowed for 12 percent, the annual interest would be $1,200. But interest expenses are deductible, so the borrowing would reduce their taxes by $400, Mr. Pechter calculates. That means the aftertax cost of the loan is $ 800.
So at the end of the first year, the couple cut its taxes by $3,700 due to depreciation. That savings was offset by the loan's net cost of $800. So the couple is ahead by $2,900.
If the $2,900 is used to pay off the $10,000 loan,''In a couple of years, they would have paid off the debt and would own equity in the rental unit,'' Mr. Pechter says.
* Using debt to help cut taxes and finance a college education. One popular approach is to borrow money, perhaps by securing a second mortgage, and then lend funds interest free to a child to help finance his education.
Experts note that there is some slight risk in such an arrangement. In the past the Internal Revenue Service has fought such loans but usually the service has lost when the issue went to court. Despite one recent court victory, IRS Commissioner Roscoe Egger Jr. earlier this month told reporters that ''we lost'' the issue and ''should leave it in the lap of Congress.''
In such a plan, an individual might borrow $50,000 and then loan the funds to a child, interest free. The child buys a certificate of deposit with the money, earning annual interest of $5,000. Since the funds are subject to taxes at the child's low rate, $4,400 might be left after taxes, Mr. Pechter estimates.
If the parent borrowed the money at 12 percent, his interest cost would be $6 ,000. But since interest expenses are tax deductible, the aftertax cost of the loan would be roughly $3,600.
''The child has $4,400 in hand, the parent is out of pocket $3,600 and we have created $800 out of nothing,'' Mr. Pechter notes.
* Borrowing to allow purchase of tax-free bonds. Advisers note that interest on a loan used to purchase tax-free municipal bonds is not deductible for tax purposes. But if, for example, an individual has saved enough money to buy a new luxury car, he might instead take a loan to finance the car and use the accumulated funds to buy a municipal bond.
If the individual bought a $20,000 bond, it might pay 10 percent annually, or considering the tax saving from deducting the interest expense, the cost would be only $1,500. So, Mr. Pechter notes, the individual has received $2,000 but paid out $1,500, leaving him ahead $500 on the transaction.