There are all sorts of arguments out there about the distinction between “good debt” and “bad debt”.
Good debt is generally defined as loans that you take out “as an investment in your future” — things like HELOCs, mortgages, and student loans. It’s also considered “good debt” to borrow money for things that might otherwise be considered “bad debt” if the interest rate is so low on the money you’re borrowing that you could make more money by investing your cash instead.
Bad debt, of course, includes things like quick loans, credit cards with high interest rates, car loans (yes, even a zero interest new car loan), etc. — basically any unsecured loans or loans secured by assets that go down in value.
I know there are people who argue up and down that some debt is good, and that you can’t buy a house or go to college without borrowing money. (Which you can do, although it’s true that many people don’t.)
But you know what?
That doesn’t make it good debt. Because, you know, “good” sounds like a desirable thing. Like ice cream on a hot day, or getting a big bonus at work. Something beneficial that we wouldn’t think twice about.
Why don’t we call all debt what it really is instead?
Risky.
That’s a heck of a lot more accurate than “good” or “bad”. (After all, debt isn’t evil either.) It’s just that some debt is a whole lot riskier than other debt — and it’s all risky.
When we go with labels like good though, we often eliminate thought from the equation. And that’s a huge mistake.
We have to put thought into deciding whether or not to borrow money. We have to evaluate the level of risk involved and how things not going perfectly might impact us if we borrow the money.
We need to ask what might happen if we borrow the money and then:
- Lose our jobs and can’t find another one for more than a year?
- The item we’re buying happens to be a dud?
- We desperately need to sell the item later but can’t?
- We graduate with an advanced degree and end up working in a call center?
- We drop out of school?
- Our vehicle catches on fire and we’re left owing what the insurance doesn’t cover?
- We forget to pay our 0% interest debt in full by the deadline?
In other words, we need to think through less-than-perfect scenarios and imagine how they might impact us, without brushing them aside mentally with an “oh but that won’t happen.” (Two of the above items happened to me.)
In many cases, borrowing money is not the smart choice, and it’s definitely not the only choice. It’s just the easiest and most obvious choice.
Don’t believe the good debt lie. Remember that all debt is risky, and be sure you’re making a choice you can live with.
Posted in Debt on 01.17.11 with 16 comments.
Thank you for such a great post. Too often we never think of the bad things that might happen. I had a lemon car that I had to deal with because of debt. Very painful experience!
Ew, lemon cars are the worst too!
I think you are right on with saying that debt is risky.
With that being said, I also think there is good debt. In fact, I just wrote a post about it. Good debt to me is any debt that where you can get a better rate of return by investing your money instead of paying off debt. For example, 0% debt is always good because you can put money in a savings account and get a guaranteed return better than 0%.
Yeah, that’s one of the scenarios that people often automatically think of as “good debt”. But it’s still risky. What if you forget to pay the 0% debt back by the deadline? Your measly return on the money in the savings account isn’t going to cover that. Most people automatically think that that won’t happen to them, but that’s exactly how the places offering to lend at 0% make their money.
I find that in the majority of cases that I see, it is optimism that is to blame for debt problems.
We are so geared up to seeing a brighter future – how on earth can it go wrong.
Nothing lasts forever good or bad.
Excellent point. And even if we do see how something could go wrong, we refuse to believe that it’s likely to happen to us.
No debt is better than a ‘good’ debt! But yes, some are unavoidable like a home and to some extent, auto.
I’m with you on the no debt being better than a “good” debt! But, I do think that very few debts are completely unavoidable (unless you owe taxes).
I think there are some good reasons to incur debt, going to college, buying a home, or starting a business. However, I don’t think I could ever think of any type of debt as “good”.
If I had things to do over, about the only thing I would have gone into debt for knowing what I know now was my first condo (because it was less than rent, even with HOA fees.) Otherwise I’m too risk averse.
Some types of debt are definitely better than others, but all debt is risky. It is important to really understand the implications of the debt.
For example, when savings account interest rates were higher, I had a car loan. I was earning 5% in my savings, but only paying 1.9% on my loan. Good debt! When savings rates dropped to nothing, I paid off the loan. No debt!
Yes, and the realization that “all debt is risky” is something so many people forget. It’s can be an unpleasant thing — to say the least — to go into debt without fully considering all of the risks.
Very interesting spin on the ‘debt debate’. I recovered from a $30k very bad debt to create a $7 million debt-free life in just 7 years.
So, yes there’s risk in all debt. But, there’s also equal or greater risk in no debt: do you think it’s possible to become a millionaire / multimillionaire in real terms (i.e. after inflation) without incurring SOME debt? And, you’ll never buy a house; certainly won’t be able to build up a decent sized real-estate investment portfolio; or, probably even start a business without incurring debt … for want of a better term, that’s ‘good debt’.
On the other hand, once the debt is incurred it becomes either Cheap Debt (in which case you should what Kevin says and invest instead of paying it off) or Expensive Debt, which you should pay off if you can, for all the reasons you state.
We all have to decide how much risk is acceptable in our individual situations, and both our comfort levels with risk and our individual living situations vary greatly.
For example, there are many areas of the US where it would be very easy to pay cash for even your first house, with little to no sacrifice. Then there are some areas where I personally don’t see the point in buying at all, unless you’ve just got so much money sitting around that you don’t know what to do with it. (Areas where rents are much, MUCH cheaper than you’d ever pay to own a house, especially when insurance is factored in.) And of course there are areas where it completely makes sense to borrow for a house — areas where the cost of renting is higher or about the same as the cost of buying.
I’ve started many started many businesses, and none of them have been started using debt.
What bothers me though is that people just assume that you can’t get by without borrowing money, and they go blindly into doing so without considering the risks. It’s one thing if you want to borrow money and have thought about how you’d handle it if things didn’t go as planned — it’s another to shrug and say oh well, that’s the only way to do it so I’ll just go ahead.
I think there is good debt and bad debt. Remember America was built on spending. If you can pay cash for let’s say to buy a house or car or pay for education in cash, then nothing can be better than that. But how many people in your neighborhood you think can do that. I bet you can count them on your 5 fingers of your left hand.
I come from a third world country. Even today credit card and other kinds of debt are almost non-existent. If the buyer wants to buy a house that’s in millions, the seller and the buyer both go to the bank where they both have accounts. Right in front of the bank manager, money in millions is transferred right there. If the buyer does not have enough, he starts looking for a house that’s lower in price.
The problem is only the rich can do that back in the old country.The absence of “good debt” has caused people to continue live in poverty. “Good Debt” is your livelihood. What many Americans have done in the last decade or so is to get loan for a house that was beyond their means.
People back there are highly uneducated but they are not dumb as some people in America where folks try to go for as much as the banks are willing to give loans for. That’s why people living in third world have stayed poor.
Banks as institutions are seldom greedy. It’s the people who have covered themselves with the blank of greed. As long as folks continue to copy what Mr. and Mrs. Jones have done and they are everywhere in every neighborhood, folks would keep getting into debt deeper and deeper.
The question is not good debt or bad debt or risky debt. The question is the greed that most Americans sleep under, the blanket of greed.
In very extreme cases, you can get into debt if you have borrowed according to your needs not your wishes. Your logic in America will not work. The best thing is to spend less than you make. Folks need some hard-core financial education. It does not exist in American schools, colleges. They get education on the street, so to speak. Even when they go through some real hardship like bankruptcy, they keep sleeping. They keep doing the same thing over and over again.
I think I better stop.
In the US — and not all that long ago, either — debt used to be considered something to be ashamed of. Then it gradually became more and more accepted, and now it’s extremely unusual if you don’t go into debt for everything and anything. So I think that labeling certain types of debt as “good” or “bad” takes the thought of risk out of the process. And yes, very many people live beyond their means using debt. They think that because they can pay the payments right now, that they can afford it. Which is not really true…