Debt is such an integral part of our daily lives that most people think it is the only way to live. I can’t even count the amount of times I’ve heard people say, “I will always have debt.” This makes me sad because it doesn’t have to be so. Debt is not necessary.
That being said, I’m not opposed to certain type of debt. I would even go as far as saying that some debt is actually good debt. Okay I take that back, no debt is good debt, but you could argue that some types of debt are not “as bad” as others.
Good Debt – a.k.a. A little better debt.
Good debt is debt that helps you build assets, helps you make more money, and/or increases your net worth. Some examples of good debt include:
Home Loan – Okay, I personally don’t think that buying a house is a must, but I also don’t think that getting a loan to buy one is a bad idea either… as long as you can afford it. The value of a house usually increases over time so a house is more of an investment than an expense.
You have to understand though, that the value of a house doesn’t always increase and there’s definitely the potential of losing money, so I wouldn’t advice you to purchase a house unless you are ready. Meaning, you have a 20% down payment and an emergency fund of 6 months to 1 year worth of expenses in case something goes wrong.
Small Business Loan – If you want to venture into entrepreneurship and don’t have all the funds necessary to start your business, a small business loan could help you. Having your own business is one of the best ways to build wealth and reach financial independence. It is always nice to know that you don’t rely on somebody other than yourself for a paycheck.
But don’t get into a business loan if you don’t have a plan for your business. Having your own business takes a lot of planning, work, and dedication. It is not as simple as “if you build it, they will come.” Just as when purchasing a home, make sure you have a hefty emergency fund to be able to cover a lot of the expenses… for at least the first year.
Student Loans – I know a lot of people will disagree with me, but if student loans help you get a college education I say go for it. A college education could help you get a better job and more importantly, a better paying job.
Obviously, it is not guaranteed that you will get a job after college or that you will be making a lot of money, but you will definitely have a better chance at finding a good paying job. Unless you have a great business idea and know what you want to do with your life… in that case, a small business loan might help.
I just want to clarify that the so called good debt that I mentioned above are NOT necessary. You could either not buy a house or you could save enough and pay for it cash… hard, but doable. You could save enough money to start your business on a small scale – your garage for example – until you build enough assets to expand. And you could work to pay for college or plan ahead. A lot of people work through college and still graduate in four years, as opposed to other people who decide to party, like me.
Bad debt is debt that is not an asset. Debt that only takes, takes, takes, but doesn’t make you money.
Credit Cards – This goes without saying, if you are using credit cards and not paying them off at the end of the month you are giving your money away. Credit card debt is one of the worst types of debt to have because the interest rates being charged are usually very high – anywhere from 15-25%. That my friend, is unacceptable.
A lot of people avoid credit cards at all cost, and I’m not against that, but you really don’t have avoid credit cards in order to stay out of debt. Just use them for things you’re already buying and collect the points/rewards. Just make sure you pay them off at the end of the month. Never, ever pay for interest. Have the credit cards company pay you instead of the other way around.
Department Stores Cards – I guess this could be tied together with the credit card debt above, but it is a little different. Credit cards could be useful for necessary expenses like food, gas, utilities, etc. Department Store Cards are not useful at all – unless you plan to only shop at one store for the rest of your life.
I say you should avoid those at all cost even if they have an amazing rewards program because chances are, you’re never going to reap the benefits; and sometimes you can get the same rewards with other credit cards.
Auto Loans – Okay this one is a little bit of a gray area. Cars are necessary and if you REALLY need a car to get to work and don’t have the money to buy a car, then getting an auto loan might be a necessity. But if you already have a car that works fine, the best thing to do is save up to pay for your next car in cash.
Also, buying a brand new car does not make financial sense. The value of the car depreciates the most the first year or two. It is better to get an almost new, slightly used car – maybe 2-3 years old. I made the mistake of financing a brand new car and not only did I end up paying more than $5,000 extra on the car’s value (after interest), but if I were to sell the car I could only get about 30% of what I paid… and my car is not that old.
I for one, will try to avoid any type of debt from now on… actually that’s not true. I might buy a house someday and I probably won’t pay cash for it. But other than that, I will try to pay cash for everything. I’m in a state of mind now that if I don’t have the money saved up for a particular item, I just don’t get it… even if I have money in my emergency fund.
What other debts would you consider good or bad?