So my dad wrote a comment on my earlier post saying that there is good and bad debt, and not having debt doesn’t mean you are good at managing your money. That is definitely true, and I feel like I need to address what I think the nuances between good and bad debt are.
First of all, I am pretty sick of people telling me that a mortgage is good debt, because it is not that simple. I think a mortgage can be good debt if the property you purchased generates cash flow. In the case of a primary residence, this means that the cost of your monthly mortgage is less than the cost to rent a similar home. In the case of a rental or investment property, this means the rent you collect covers your mortgage and maintenance costs. Additionally there is the possibility of asset appreciation, but that is an uncertain factor that should be measured conservatively. A mortgage is definitely bad debt if you can’t afford it or if you have to stretch your finances extremely thin to afford it. If you are losing buckets of money by taking on a mortgage, then it is bad debt.
Another iffy type of debt is student loans. A lot of people consider them to be good debt because they financed an education, but I think student loans can also be bad debt if the education was never put to use or if the interest rates are extraordinarily high. Then again, it’s hard to gauge the future when you are young, idealistic, and have a passion for learning. However, it is possible to figure out the approximate salary you could potentially receive by finishing a certain degree.
Credit card debt is another thing that could be good or bad. If your credit card debt has 0% interest, it is possible to leverage that money into safe investments and pay the credit card company back. In fact a whole group of people have taken advantage of this in the past few years when bank interest rates were high. However, most people who have credit card debt are in a situation where they are paying extremely high interest rates on purchases of useless items. That is extremely bad debt.
So what’s the bottom line? I think good debt is basically debt you could make a profit on and bad debt is the debt that make you have less than what you started with. It is hard to figure out which is which in some situations, but when you realize you have bad debt you should work on eliminating it as soon as possible.
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10 comments ↓
Interesting look at debt.
I think maybe “good” and “bad” is too simplistic for various debts. Personally, while I agree with the general idea that secured debts (ie real estate, investments) are better than unsecured (debts because of a vacation) I think that really it’s the size of the debt that is more significant. If someone has a manageable amount of debt that they are paying off in a reasonable fashion then I would say that debt is better than someone with a mountain of a mortgage that is hurting them financially.
Mike
I agree with your analysis and Mike’s as well. Since our society is build on debt and credit is easy to obtain, it’s too easy to fall into “enjoy now, pay later.” It takes a conscious effort to go against the grain.
Very good points! I especially hate when everyone assumes that student loan debt is good debt no matter what. Learning for the sake of learning (i.e. studying the liberal arts) is necessary and should be done – but not to the tune of $30K/yr financed at 12%!
I agree, especially with the student loans. There are other ways to finance a higher education than going into debt needlessly. State Universities and especially Community Colleges are a good bang for the buck. Taking out private loans to pay for an education is generally a bad idea as well.
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Good and bad debt pretty good article. Yes a home is only a good investment if you are getting cash flow. Waiting for appreciation is not always safe. Plus that mortgage going to kick your ass while your try to pay it off if your in the bay area like I am.
Credit cards are not bad it’s like free loan with high interest if you use it to invest correctly.
[...] debt is debt that you leverage to create something. Bad debt is money you spend on credit for things that are completely useless. Let’s look at this way. You [...]
Some very fair points… your readers may find some good debt discussion here: http://www.debtadvisersdirect.co.uk/Debt-News.asp
[...] debt is debt that you leverage to create something. Bad debt is money you spend on credit for things that are completely useless. Let’s look at this way. You [...]
If you are struggling to repay debt then all debt is bad – even if you originally considered it to be ‘good debt’. There are ways to become debt free, and it is essential that you get your finances in order ASAP.
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