The Good Debt/Bad Debt Debate

The Good Debt/Bad Debt Debate

I know I'm opening up a gigantic can of worms here so I'll preface this post by saying that I am in the interest of studying personal finance which is, by definition, personal, so each person has their own opinion on it. Opinions are always welcome here, as well as experiences, expertise, and emotions. Negativity and nastiness are banned. So, feel free to give us your opinion on the great debate in the comments but keep it nice and positive.



The following statement was copy and pasted from Debt.org, "America's Debt Help Organization". Let's dissect it.

By definition, debt is simply the process of one party borrowing money from another party. And for most of us, debt is a necessary part of life.

We borrow money so that we can buy goods or services that we could otherwise not afford right now. We borrow with the promise and expectation of repaying the borrowed funds sometime in the future – a time when expect to have money to do so.

That reality makes it wise for all borrowers to weigh their overall balance of good debt vs. bad debt.

Well they do get one thing 100% accurate: Debt is simply the process of one party borrowing money from another party. I think it all goes downhill from there.

"Debt is a necessary part of life."

I think the word they are trying to think of is normal, not necessary. Debt is normal because "everyone does it" and so that has made it an accepted practice in our society. People who are truly financially responsible, meaning that they live on a budget and have a plan and goals for their money know that going in to debt is never necessary.

"We borrow money so that we can buy goods or services that we could otherwise not afford right now."

We definitely live in an instant gratification society. If we can't afford what we want right this second, we just whip out that credit card and swipe it, vowing to pay it off as soon as we get home. Or, we sign the papers and buy the car because we can afford the monthly payments. Because we cannot afford it right now, and we have become wired to feel that we deserve it anyways, we make excuses to justify buying things we cannot afford.

"We borrow with the promise and expectation of repaying the borrowed funds sometime in the future – a time when expect to have money to do so."

This statement forgets one very important thing: RISK. We promise to pay it back when we have the money but that is a really dangerous promise to make. It is why there is billions in overdraft fees paid to banks every year and millions of dollars being collected for bad debts. You cannot make a promise that you'll pay something back when you can't guarantee your financial future. And the more you make that promise, the thinner and thinner it becomes.

"That reality makes it wise for all borrowers to weigh their overall balance of good debt vs. bad debt."

I think this should say "weigh their overall balance of debt vs. no debt" because in no case is borrowing money a good idea. This also implies that having a certain amount of "good debt" cancels out the "bad debt" when really, together they dangerously tip the scales.

What is considered a good debt?

Taking out a mortgage: Mortgages are rationalized by the fact that generally speaking, home values increase over time and that the interest you pay on your mortgage is tax deductible.

Paying for a house in cash is incredibly difficult but owing money on the most expensive asset you have in your portfolio only increases your risk. Getting it paid off as soon as possible, regardless of the tax savings, secures the value of the home as a true asset and increases your net worth.

Financing a vehicle: If I can afford the monthly payments, I can afford the car.

Financing a car is the equivalent of throwing a $100 bill out the window once a week. Cars go down in value faster than you can get it paid off so by the time you are done making payments, it is likely worth less than what you paid in interest over the years.

Borrowing to save time and money: Borrowing money on things like home improvements and weatherizing your home will help you bring more in when you sell the home or save money on your utilities bills.

The hope is that it will save you time and money but the reality is when you tack on interest and the fact that your income is not being used to invest in your emergency fund, children's college funds, or retirement, then it is really not a savings at all.

Investing in School: Borrowing thousands of dollars in student loans to cover school expenses will guarantee a better paying job. Money borrowed for higher education will pay for itself over and over again.

Until you graduate, start your adult life with a $30,000 anchor tied to your neck, and desperately take the first job that comes along just to make the minimum payments on your student loans. Desperation is a nasty friend to bring with you to a job interview.

Borrowing for Business: Signing a loan in order to build wealth and grow is a great way to invest in yourself and your business.

Except when even with the seed capital, the marketplace is not receptive to your business and you have to shut the doors. Or when you do start making money, instead of then reinvesting it in to your business, you have to send it all to the bank. It is working backwards, not forwards!

What is considered bad debt?

Just about the only thing that society considers a bad debt is a high interest credit card. However, they still rely on them for day to day purchases and as an emergency fun because they have a 1% cashback bonus or give you points to buy airline tickets with.

Speaking from experience, I have a credit card (it is next in our debt snowball and has been cut up for over a year) and after using it and carrying a balance on it for nearly ten years, finally built up enough points to purchase a $300 plane ticket. Hear me when I say, I would have much rather had my life back over the last ten years than pay for a plane ticket with credit card points. The cost is no longer worth it to me.

Let's Chat About It

So there are my opinions on this whole good debt/bad debt debate. I'd love to hear yours! Let's start a healthy discussion in the comments below and fill me in on some experiences you have had with debt in your life. How has it been good or bad for you?