What are the Basic Principles of Borrowing?
Principle 1: Borrow for something that you need – not want.
We have talked about the difference between a Need and a Want before and when it comes to borrowing, it’s even more important that we understand this difference. You should only borrow for something that you really need but don’t have the cash to pay for it. For example, to purchase of our home, to send our children for further education and to a lesser extent, to buy a car (we’ll talk about this later).
Principle 2: Borrow an amount that is within your repayment capacity
It is advocated that one should keep one’s total loan repayments to less than 1/3 of one’s gross income.
This might ruffle some feathers but it’s nevertheless a good principle to abide to. Depreciating assets are things that lose its value over time, like a car (unless you’re “investing” in a classic car), furniture and most of the household items & gizmos. It doesn’t take an economics professor to tell you that borrowing at a relatively high cost (maybe as high as 20% p.a. for some items!) to purchase these “assets” just doesn’t make good economic sense. These items would depreciate very quickly in value whilst your loans reduce rather slowly. In the event of default, the items would be repossessed and you are obligated to top-up the shortfall as your depreciated assets are not sufficient to cover the outstanding loans.
Principle 4: Avoid Being a Guarantor
Principle 5: The Borrower has a Moral and Absolute Commitment to Repay