What are the conditions under which borrowing is a good option?

Jul 8, 2013, 08.00AM IST

(There are, indeed, instances…)

Ashwin Murthy, who works in a multinational company and earns a decent salary, believes that he does not need a credit card. He is single and looks ahead at his life with the confidence of a disciplined saver. He thinks he should save money, instead of borrowing it, in order to buy the things he needs. Murthy is of the opinion that loans are traps laid out by lenders and wonders why one should borrow at all. What are the possible flaws in Murthy's way of thinking?

Ashwin Murthy follows the rule book of the righteous elders, who strongly discourage borrowing. There are, indeed, instances where people have suffered because they have borrowed. To save is to set aside money for yourself, but to borrow is to use money that you have not earned. However, this conservative reasoning may not always help in asset building. Borrowing offers the benefit of leverage, which, if used judiciously, could turn out to be a smart way to build assets.

For instance, buying a home might be tough if Murthy plans to fund it entirely with his savings. In the period that he accumulates this amount, the housing prices could move up, making it tough for him to buy this asset. He may find that borrowing, especially with the tax concessions, might result in a low-cost loan to acquire an appreciating asset such as property.

While Murthy may want to avoid needless loans, he may find it useful to take the ones that can help him tide over temporary requirement without much pain. He must remember that in order to be able to access loans, when needed, he will need a credit track record. A credit card, for which payments have been made regularly, provides the required credit history to take a loan. It will do Murthy well like to consider the advantages of reasonable amounts of borrowings without completely closing himself to the possible benefits.

The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre and Arti Bhargava.