Good Debt versus Bad Debt
What about the argument that there is good debt versus bad debt?
As I have mentioned here many times, the core reason for this blog is to teach basic money management skills to nurses.
Debt is obviously a common money problem-obvious to all, unless you have been sailing around the world for the last 7 years….
photo by alancleaver-2000
And like many of you, if I am starting my research on something, like an article on debt for this blog, what do I do?
I go to Google-so I googled “good debt versus bad debt.” The first non-advertised link, was an article in MSM, submitted by bankrate-articulating many of the old arguments.
The third article on the list is from MSM Money-(way to go MSM-I am jealous of their google juice!).
It has this quote-”Good debt includes anything you need but can’t afford to pay for up front without wiping out cash reserves or liquidating all your investments.” This sounds like Yogi Berra in the barbershop explaining why you need AFLAC.
What the heck does that mean? “Anything you need.”
Now, I don’t know about you, but I can be pretty creative about things I need. How many people need the new i-Pad, a new car, or even a haircut. Does that mean if I put those on my credit card, they are “good debts?”
Is a Mortgage, Good Debt?
Some argue that mortgage or other real estate debt is ok as it is an appreciating asset.(something you own that is increasing in value)
Is Business Debt, Good Debt?
The same for money borrowed to advance their business-it will help GROW the business-so it is all good.
Is Student Debt, Good Debt?
Student debt is also good, in that it allows you to grow your income.
Is Good Debt a Hedge Against Inflation?
Many argue these so-called good debts are inflation hedges-as they increase in value overtime, or allow you to increase your income. Therefore these represent a wise financial strategy.
David Bach, for example, a respected personal finance guru, strongly encourages home ownership as a wealth building tool. His example is that home appreciation averages 6.5%-Allowing many people to build wealth, while they are sleeping.
This video was obviously done after the housing bust. And I agree with him on many of his points. But I think the idea that renting is bad, is not nearly as straightforward now as it was in years past. Price vs rent ratios have been used for years to decide whether markets for buying homes were favorable. As you can see at this NY Times site, the housing markets in many cities are still overpriced compared to the rental market.
What those people who think good debt is ok are forgetting is that any debt, increases your risk. Did any of the folks buying their home during the real estate boom, think their debt was risky?
Home prices were increasing 5-to even 25% per year for many years running. All their friends were buying homes, and not just a few were flipping them for a huge profit.
Now those same homes have dropped in value-the average nationwide is about 30%. Many in the boom areas of our country have dropped 60% or more. How many years will it take homeowners in those areas to get back to neutral, much less building wealth in their home.
Those same people now are facing a struggle, with their home “upside down” or worth less than they owe. They now need to move to find a job, but can’t sell their home for anywhere close to the amount they owe.
And banks are kinda weird in that they want the money you owe them. And the banks don’t really give a rat’s ass that the home is now worth 30% less than it will get on the market, they still expect you to pay….. (They actually do care if you go into foreclosure, as then they have to sell the home and book the loss! )
I do agree that with the current price of housing and the interest rate’s being at historic lows, that now is a great time to buy a home. But only if you are financially prepared, and are ready for the responsibilities of home ownership, not because it is a great financial tool-to build wealth.
Now what about other “so called” good debt.
Student loans are mentioned as good debt in many articles- as they allow you to earn more income. But what happens when you borrow money, but don’t finish the degree because “stuff happens” or you decide to quit to “go find yourself”. Or you borrow more than your new job’s income stream will allow loan payback without financial hardship.
Nurses are lucky in that there are loan repayment programs available-but not every field has these options. And if you don’t finish your program-obviously these programs have no value.
Debt
So, think about your justifications for borrowing money, before it is too late! Be sure you can afford whatever debt you choose to carry, and by all means eliminate consumer debt ASAP, but don’t forget all debt has RISK!
Reader Questions about Good Debt:
What are your thoughts about Good Debt vs Bad Debt?
Have you gotten into a so-called “good debt” that turned into a nightmare for you?
Share your thoughts with our readers, so they can learn from your mistakes or concerns!
But be careful when you try to justify your debts as good debts, as that may be a trap you can’t get out of.
Tags: good debt, Good debt vs bad debt, is their good debt, what is "good" debt
In the end, debt is debt. I understand the reasoning for saying that mortgage or student loan debt is ‘good’ debt, because like the house, they either provide you with something tangible that (at least until recently) holds value or in the case of student loans act as an investment in providing greater earnings potential. That’s all fine and makes sense, but you have to be realistic about what you can afford and how you plan on paying for it.
Another thing to keep in mind is that once you take on the debt, I think the terms of ‘good’ and ‘bad’ take on a different meaning. Once you’re in debt, at that point it really doesn’t matter what the debt is covering, because you’ve already made the decision. You then have to look at the ‘bad’ debt as the one you can get out of first. Because, for so many of us, getting out of debt is the whole goal, right?
For the record, our debt consists only of student loan and mortgage debt. Still, I can’t wait to get out from under both!
I agree with your first statement. I think sometimes it is easy to justify going into debt, because others have said it’s good debt.
In the long run, that may or may not be true, but all debt has risk. And sometimes that risk is ignored, as our recent housing crisis has shown!
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These days in this topsy-turvy time what used to be the rule has changed. It used to be that your home mortgage was the definition of good debt, but when you are completely “underwater” on your property, it has to be called bad – just plain bad.
Someday this will turn around, and if you are lucky enough to keep your house, you will recoup most of your losses – at least no-one is alone if they are going through some major collapse in their personal finances.
I think the debt on your home is absolutely good debt, regardless of whether you are underwater or not – assuming you bought it for all the right reasons: it was meant to be your primary residence, you bought an affordable home that was well within your means, and you didn’t buy it as an “investment.” I think to consider it bad debt is to suggest that you should only pay cash for a new home – and how many people will ever be able to afford to do that?
I will also argue that a loan to start up or expand a business is good debt, assuming the proper market research and due diligence was done before hand. In business, most of the time you need to spend money to make money – especially in businesses with high barriers to entry.
I think school debt is a bit tougher to argue. Spending $100,000 or more for a degree in history, liberal arts, or underwater basket weaving is not very smart, IMO. If it’s a valuable high-demand degree like medicine, pharmacology, engineering, or some other degree rooted in science or math – you can at least make an argument you’ll get your money back in a reasonable amount of time. Still; a prudent person can often get the same degrees for a lot less if they shop around, with little impact to their job prospects over the more prestigious universities.
Everything else is bad debt.
Best,
Len
Len Penzo dot Com
Len, I think the main point I would make is though your assumptions are accurate, they are not always true. People do buy their home, the most expensive thing they will ever own, without doing their due diligence. People do borrow money to go into business who know nothing about running a business.
Now banks are clamping down on who they loan money to at this time. Maybe they will help us from being our own worst enemy. But we all know that will change as they get their books in order, which won’t take long with the significant spreads they are operating with right now.
I am not a “debt” Nazi, I use debt to leverage my business, and have a mortgage. But it is so easy to not consider the risks, just because everyone else is doing it.
I just want people to look both ways before they cross the street!
Great post! I definitely agree with you – I can make a pretty strong argument for “good debt needs.” I applied for and received a student loan for my graduate school; four years later and we’re feverishly working to pay it off. It’s our only debt.
We rent our home currently. We recently looked into buying and made the tough decision not to purchase. We didn’t want to financially strap ourselves to keep up with the Joneses (who are eye-balls deep in debt anyway yet pretend otherwise!). It was a difficult decision because we often feel like we “need” a house with a back yard, in the “right” neighborhood, etc. I’m glad we’ve delayed the purchase. We have a solid plan for paying off this last debt and saving like crazy. I look forward to the day we can lay down a stack of cash and minimize our mortgage debt as much as possible.
Great job. Although the housing market is great for buyers right now, with good prices, and great interest rates-it is still a huge decision. Only to be done when YOU are ready. The home will feel even more special, if it is not a stress financially!
Good luck!
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