When resources such as monies are given to another person with a condition that the monies have to be returned, the amount is said to be a loan or credit. Generally, such credit carries interest, which may be payable weekly, monthly, quarterly, half-yearly, or yearly. Therefore, the interest quoted on such credits is interest per annum. Though many religions forbid it, there are situations when such interest is justified. Take for instance a person saving monies for purchasing a home. Just when the deal is about to materialize, his friend meets with an accident, and money is required to meet hospital expenses. So the person forgoes his desire, and surrenders part of his money so that the friend’s life can be saved. The friend recoups. Two years down the road, the same house is up for sale again. But this time, it is 10 percent costlier. Under these circumstances, it would only be right on the part of the friend who met with accident to voluntarily pay the entire sum that was spent on him along with that additional 10 percent, even if it works out to be almost 30 percent or more for him. This is called the opportunity cost, and is normally collected in form of interest.

Many people fear credit and rightly so. Credit can truly get out of hand, if not managed with strict discipline. Nevertheless, life without any credit can be full of financial problems as well. Imagine there being no home loans available for purchasing that home. The person would continue to slog for rent till he or she could accumulate enough savings to buy a home. That, of course, would be remotely possibility, with inflation eating away the value of savings, and the house prices climbing each year. Effectively, a home would remain out of reach for most. This would help to keep the rich perpetually rich and the poor perpetually poor. So credit may be good to an extent.

Consider the case of a proprietor starting business with his money. He invests $10,000 and is able to generate a return of $1,200 per year on it. Let us presume inflation steals $200 from that return. Effectively, the proprietor is left with $1000. The following year the proprietor is again able to generate $1,200. But this year, the additional inflation leaves him with lesser amounts in hand. This is because inflation compounds annually. Therefore, the person is steadily getting lesser returns, while his living costs are going up. He does have an option to increase the sale price of his products. But this is governed not by his finances, but what the market dictates. If he tries to depart with prevailing market conditions, chances are his product would lose market share completely, and the proprietor may have to close down the business well ahead of schedule. The next question that comes to the mind is: how are competitors able to offer the product at a more competitive price in the same market conditions? The competitor may have installed a machine that produces more of such products in lesser time, with lesser labor, and may be operating from a place where labor is cheaper, rental is lower, and there are concessions for starting a manufacturing unit. One such factor is the credit taken by the competitor to install the machine with higher capacity. When a competitor takes such credit, he ensures that what he is earning exceeds the interest cost on the credit or loan. This is called financial gearing. Effectively, the competitor utilized the funds from a bank to fetch him better returns, and paid nominal interest rate on credit from the bank. Apart from this, the competitor is able to reduce this interest burden still further by claiming tax rebates on depreciation and interest costs. When any such credit is taken, and repaid over a longer period, it works to the advantage of the borrower. This is because the money that leaves towards loan repayment keeps losing value because of the effect of inflation.

Based on this, it may be concluded that all credit is not bad. In fact, credit is good, if it can be obtained at a rate of interest less than the rate of interest or returns that the borrower can generate. In personal lives, the borrower should be able to assess the extent of credit burden he or she can carry. If the borrower is truly unable to assess this, then approaching a financial advisor may be a smart option.