Basic principles of borrowing money

One of the basic principles in borrowing money is that the interest and other costs of obtaining the loan are less than the value that is created by borrowing the money. As an example, if one borrows money at 4% and creates a 7% return, all else being equal, then there is a 3% profit return on that investment. The goal is to get the greatest rate of return with the lowest cost so profits are maximized.

Assets such as houses and businesses can be used as collateral to secure a loan. One can also use a consumer asset such as a car or a credit line. But when should one borrow and when should it be paid? Or what is the true purpose of why you borrow money?

There are a lot of factors on how you will determine of why you borrow money. Money should be borrowed against assets that produce an income. Commercial and investment real estate and other business operations produce income since the asset is used in business to provide a valuable service to another for money. This income can then be used to service the debt owed on the asset. Personal assets such as primary residences, cars, and personal lines of credit do not produce income.

You can also borrow money against assets that would, over the long-term, appreciate in value. Even if the income for the use of the asset did not provide enough income to pay off the debt, the eventual sale of the asset would be at a higher value in the future so the debt could be retired upon sale. Commercial and investment real estate have the potential for appreciation as well as businesses as they grow in value through expansion. Primary residences may or may not appreciate in value, depending on the market and holding period. Consumable assets such as cars, boats, and personal credit lines do not appreciate but decline in value.

When you are determining whether to borrow or not, you will really have to know the purpose of borrowing. To borrow the money at the lowest net cost and generate the greatest value possible with the proceeds is the wisest thing to do.