What makes one person more capable of making wise informed financial decisions, more than another person? Maturity? Experience? Intelligence? Education? Most likely, it's a combination of experience and common sense. There's no lesson quite as meaningful as the one we learn from a bad first-hand experience so, very often, the best advice will come from someone who's been burnt financially in the past!
It might seem that it's wise to never ever borrow and just live within our means throughout our whole lives. While there's certainly something to be said for that, debt is not always a bad thing. It's not necessarily wise to suggest to a young person or a potential mortgage-holder that they simply resist the urge to borrow. Effective debt-management often makes a great deal more sense than a total lack of debts in the first place. After all, one of the main criteria that banks use when assessing an applicant's suitability for a loan is credit rating i.e. the applicant's history of borrowing and, more importantly, history of repaying.
No amount of financial education can match life experience. The older generation are often at pains to point out to college leavers and young married couples that they shouldn't get in over their heads with borrowing because banks can suck us dry. That is true and, although the temptation might be to rush in and borrow regardless of such advice, it's wise to pay heed to such advice, though you don't have to be quite as cautious as all that!
Financial wisdom, in short, is knowing that indebtedness, in itself, is not necessarily a bad thing but it's the amount of debts and the quality of debts that's very important to consider. For example, the decision to buy a house requires a great deal of planning and some very serious shopping around.
Some points to consider:
- How much can you afford to pay back?
- Never ever over-borrow. Banks have a habit of making an extra $10,000 in mortgage debt seem like nothing when it's broken down into 12 months a year over 30 years. What's a few extra dollars a week after all? Well that kind of thinking is exactly what will land you in trouble in a few years. A few extra dollars a week on every borrowing we undertake in our lives quickly adds up to a debt we cannot afford. So, in other words, taking our a mortgage is wise, taking out a mortgage we cannot afford is unwise.
- What is the interest rate?
In the early and mid nighties there was a huge influx of new lenders to the market. Every Tom, Dick and Harry thought they had the know-how to advise us on our financial futures and every street was awash with new mortgage lenders offering competitive rates or tempting perks, for example, 'free legal fees', '100% mortgages offered' or 'no repayments for the first year'. Those so-called 'benefits' might seem tempting at first glance but when we're dealing with an outlay of $200k or $300k, those 'perks' are meaningless. What really matters is the interest rate. If one bank is charging 5% over 30 years and another is charging 5.5% but offering 'no repayment for 6 months', do you know how much extra you'll end paying to the latter bank? On a mortgage of $200k over 30 years that extra .5% adds up to $30k so do you still think that 6-months no-repayment offer is good?
Financial wisdom comes from experience and if that experience is combined with basic common sense (e.g. the ability to see past tempting 'offers') you'll have all the financial wisdom you need to make it through life without crippling debts.
I have many hobbies except finance. One of them is writing on how to do people search for free and reconnect with people.