The good and the bad of debt

FarmBiz|June 2020

The good and the bad of debt
I think part of my dislike in debt stems from the house I grew up in. I believe for many other Afrikaans families it was much the same. We were warned against debt from a very young age. If you cannot afford something, you have to save until you can buy it. You simply do not borrow money to buy it. In fact, you do not borrow anything – you save until you can purchase it on your own.
Dr Frikkie Mare

The fact of the matter is, however, that very few of us can go through life debt-free. I work for a salary and for me it would be next to impossible to purchase a car or home without the necessary financing. Although debt is certainly not our first choice, it is something that we can barely live without.

Agriculture is a capital intensive sector and it is only in very rare cases that you will find producers who do not need some or other type of financing. Debt can, however, be good or bad, and there are various avenues through which to acquire financing.

Good vs bad debt

Basically there is no fixed definition that distinguishes between good and bad debt. Some sources refer to bad debt as debt with high-interest rates, while others regard debt as good, as long as you can afford the down payment, and bad when you cannot. Does this then mean that when you need a R500 000 tractor, but you purchase a R1 million tractor simply because you can afford the down payment, it is still good debt?

In my view the difference between good and bad debt in agriculture is the purpose and outcomes of the loan. When debt is detrimental to your overall wealth, it is bad. When it is beneficial to your wealth, it is good.

The concept of ‘leverage’ in layman’s financial terms, refers to the use of your own money, together with borrowed money, to make more money and therefore create wealth. This equals good debt. However, if you use borrowed money to fund luxury items that lose their value over time without having contributed to the creation of money (wealth), it entails bad debt.

Debt can, however, be incurred with the intention of creating more wealth by using it as leverage. The assumptions relating to a future estimation may, however, not be realistic and will cause the down payment to become unaffordable. In such a case intentional good debt might become very bad, very quickly.

Types and sources of financing

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June 2020