Business 101: All Debt is Not Created Equal

For any business, managing debt and cash flow is crucial to survival. Commercial fishing is not any different. The Covid-19 pandemic has shed a light on the issue, particularly for those companies that have done a poor job in this area. A company needs to find its balance in terms of maintaining stability. It’s important to understand how debt can be beneficial for maintaining that balance. I have been advising my clients for many years to have at least three months of income as an emergency fund saved; six months would be preferable. You never know exactly what surprises are going to be thrown at you and having an emergency fund is critical. You don’t want a short-term problem to ruin your long-term plans. For many people this is a recurring problem. Often times I have clients take funds from their retirement accounts to pay for a short-term expense. They don’t realize how much they are hurting their future plans. Make sure you have funds available for these unwanted surprises. There is a difference between good debt and bad debt. Some say, “Isn’t all debt bad?” The answer is “Not really.” For example, credit card debt with high interest rates is bad debt and should be avoided if at all possible. I met with a client recently who bragged about her rewards credit card and all the points she had accumulated. She had a $25,000 balance on the card at an 18% interest rate so her “free trip” was costing her $4,500 in interest payments. In contrast, mortgage rates are near all-time lows. Purchasing a home that likely will grow in value at a rate higher than the interest payments can be a smart way to accumulate wealth over time. I am often asked about paying down debt. Of course, I suggest getting rid of high-interest-rate debt such as credit cards as soon as possible. However, I wouldn’t rush to pay off low-interest fixed-rate mortgages and sacrifice your retirement or investment accounts. For example, if you have investment accounts averaging 7% over a long period of time, it would not be beneficial to pay down a mortgage at 3.5%, especially if you are able to itemize your deductions when filing your taxes. I worked with a lobsterman last year who had paid off his land and his truck thinking that he would get a tax deduction because they were both used for work. Those items are typically amortized over years for tax purposes, however, and by using his available money to pay them off he left himself without enough funds to pay the taxes he owed. Lastly, be careful of home equity loans. I’m not suggesting they are bad, however, the majority of home equity loans are variable rate loans. If you have a variable rate home equity loan then when interest rates start to climb so will the rate on the loan, making your payment significantly higher than when you originally started. Each person’s situation is different, of course, but you should be aware of the terms of the loan and make sure that if rates climb quickly that you have an exit strategy for that debt.

Michael A. Godin is a LPL financial planner at Twin Cities Financial Group in Lewiston.

If you are struggling with getting a handle on managing your cash flow and debt it may be worth spending some time with a financial planner to help get you on the right path.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisor.  Member FINRA/SIPC.

Small Business Resources The Maine Department of Economic and Community Development, through its Business Answers Program, connects new and existing businesses with the various state departments and agencies responsible for specific licenses, permits, rules and regulations. The Maine Small Business Development Center is a partnership program with the State of Maine, the federal Small Business Administration and the University of Southern Maine. The Center’s business counselors will provide assistance to start and expand your business. SCORE is a network of entrepreneurs, business lenders and executives who volunteer as mentors to the small business community providing assistance to help entrepreneurs start businesses, grow companies and create jobs in local communities.  The web site for SCORE in Maine is http://scoremaine.org. The Women’s Business Centers provide business training, coaching and mentoring and other assistance geared toward women, particularly those who are socially and economically disadvantaged. The web site for Women’s Business Centers is www.wbdc.org.