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Friday, March 8, 2013

The Risks of Taking on Debt

Lessons Learned From the Real Estate "Bust"

I was recently researching the tax records of a property I want to to buy and noticed that the house had been refinanced numerous times only to end in foreclosure. I think it's a good example of how some people use debt to fund their lifestyle and the risks of taking on debt.

taking on too much debt

Because real estate in general was moving up in value a lot of people were looking at the equity in their houses and looking for ways to use it. A lot of this was fueled by the multiple offers that mortgage lenders would make homeowners to try and convince them to refinance.

That whole approach of banks trying to get homeowners to refinance their homes was very irresponsible and greedy. They wanted to sell mortgages so they were coming up with all these fantastic mortgage types...ARM's, stated income loans, interest only loans, etc.

Basically anything that they could come up with, as long as it was legal (whether ethical or not), to put as many people as they could in mortgages.

Now, we as consumers have a responsibility too. After all at the end of the day we are the ones who sign on the dotted line. We have to take responsibility to what we commit to and we have to do our homework and find out if what we are doing is right, legal and the smart thing to do for our own particular situation.

But the way these banks were advertising these loans they would prominently highlight two things: the monthly payment and how much cash you could get out of the refi. While leaving the terms of the mortgage to the fine print on the back page of the promotion letter...

For many people the temptation of money back even if payments got higher was too much to resist. After all the value of their property was going up…and will keep doing so…right????

The reason I bring this up is just to illustrate once again how taking on debt is almost always a bad idea. I say almost because there are instances where debt can be of help. For example, I have been able to profit significantly from debt in the last couple of years since I have borrowed money to buy real estate to resell for a profit. Debt also allows us to buy a car or a house to live in right now.

But nevertheless regardless of how carefully you use debt you always need to recognize the following:

  • Using debt carries a risk, always has, always will
  • You have to take responsibility for your own actions - just because it's legal, or you can make the payments, or everyone else is doing it does not mean it's good for you
  • Real estate only becomes an asset when you own it 100% - if you have a mortgage on any real estate, you don't really own it and it is a liability and adds risk to your life
  • A high consumption lifestyle paid for with debt (credit cards, loans, home equity, etc.) is the great American trap - it's a trap because it's designed to always keep you in a state of debt, never getting out of it. In America this has become "normal"…Debt is the opposite of wealth - as long as you have debt in your life you will not be able to reach financial independence
I believe that you can learn as much from failures as you can from successes. The hundreds of thousands of foreclosures that we have seen in this country over the last couple of years are a powerful lesson for you and me about debt and it's risks.

QUESTION: When do you think debt is a good or bad idea?

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