Good Debt Vs. Bad Debt

Good Debt vs Bad Debt

All debt is bad… or is it?

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

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? 

 

31 Comments

  1. I agree with these, although there are certain situations where any of these debts could be good or bad. For example, when someone takes out 100K in student loans to earn a Master’s degree in Liberal Arts! =)

    • I totally agree with that. There are definitely situations where the so called “good debt” are a baaaaad idea. Your example is one of them.

  2. Agreed! And, I also agree that debt doesn’t have to be a part of life. It’s totally possible to live debt-free (or with just a mortgage). I also agree with Holly–I don’t think all student loan debt is good. I do think a college education can be a good thing, but not at the expense of your long-term financial health.

  3. I try to avoid labeling debt when I can, although I don’t disagree with how you’ve labeled them. The reason I try to avoid good or bad is because people particularly hold onto to the “good” label. To me, debt is debt. I’ve seen lots of people get something into financial trouble with “good” debt because they didn’t due their due diligence. They didn’t assess the risk and make sure it was not only reasonable but didn’t have a plan in place in case something happened. They assumed because it was “good” that it was safe. And that is not necessarily true.

    • You’re right, Shannon. Labeling them as good is probably not the right approach because of the reasons you have stated. I just wanted to make a distinction that some debt are clearly worse than others. But agree that all debt should be treated the same.

  4. I am with Shannon, I don’t typically label debt good or bad. I may argue that student loan debt is bad especially if you could have gone to a cheaper school or taken out less and far as cost of living, etc. I just think that people need to be smart about how much debt they take on and how they manage it. Debt can be a strategic part of your financial plan but only if you are smart about it.

    • Agreed. I don’t think it’s smart for people to go into debt just because they want to go to a particular school, when a cheaper school offers the same classes.

    • You’re going to be so happy when you pay off all your credit cards… I know I was. Now I just have to finish the student loans and I’ll be jumping up and down with joy.

  6. After my student loans are gone, I’ll only go into debt for a home (of course after putting 10-20% down). I don’t see the point in having any other debt whatsoever. I hope that my planning ahead will eliminate the need for my future children to need student loans – I wouldn’t want anyone to have to go through what I’m going through with that kind of debt!

  7. Right now all of them are bad for me. I am just so looking forward to paying them off… and hopefully I can get into a “good debt” someday and own a house also!

  8. Home, car, education. That is it. We have even been able to avoid car and education luckily which helped us get a great start in our financial life. My company runs on a cash only philosophy. We have studied whether it would be worthwhile to take on debt to expand faster than what we can do naturally. It looks great on paper, but we’ve been a great company for 30 years so why mess it up so we’ll continue to grow at our natural rate.

  9. Totally agree. Good debt are ones that can increase your earning potentials. Any other debt should be considered as bad debt.

  10. Yeah, labeling debt is kind of a foolish endeavor, because of the distinctions you draw. Not all debt is bad, and some may be beneficial, depending on the circumstances. That’s something I think many anti-debt people tend to forget: if used intelligently, debt is just another tool in our arsenal, not the big bad monster we often pretend it is. Good read!

  11. Out of these I would only say a home loan is potentially good. I can count the number of times I’ve heard people’s student loan stories…about how they have all this debt for a degree they can’t use. Better to not go to school for a time, get a job and store up cash than attend right after high school using debt, imo. And I’d definitely find a way to start my business small with very little start up costs. Entrepreneurship is extremely risky and I wouldn’t want to be saddled with thousands in debt if I failed for some reason. Great post!

    • You’re right, I think you should get a college education without having to go into debt, but I’m also not opposed to it – within reason.

  14. I’m mostly on board with this post too, as long as you know what you’re getting a student loan for and have a plan to get in and out as fast as possible. It’s a similar situation to getting a small business loan to me. You wouldn’t start a small business and take out a six-figure loan with no real plan to pay it back (the bank probably wouldn’t give you a loan either). But, that’s what many people are doing with their education currently.

    On a small side note, I do have a credit card I use regularly for all my online shopping. I’ve had too many issues with processing accounts and online subscriptions for me to be giving out my debit card number online. It seems like every other week some large company has an entire bank of credit card numbers stolen. At least if someone steals my credit card number, they won’t be stealing my money.

  15. I personally financed the purchase of a business with a loan in the past and I never looked back. The loan was paid off within a couple of years during which time I was earning a decent income from the business and I then sold the business a few years ago for more than I paid for it as it had grown over the years I owned it. So I totally agree, borrowing to start or buy a business can certainly be a good thing.

  16. While there is really no way to save enough for college in any real substantial way on a high school diploma (as income levels of the uneducated are really sad), it can be really great for applying for financial aid. Take the time to establish that you’re an independent adult and you don’t have to list the income of your parents on your forms. Not to mention, so many teens have no idea what the world is like. Having to live on a low income can really be eye-opening. Even so, student loans are nearly a requirement now, even for technical schools. 🙁 So, I guess they’re not really “good” but more “necessary” to my mind.

  17. I don’t like any of my debt so I’ll call it all bad;0) The mortgage is the one debt I’m the most okay with. I’m hoping our kids don’t have to accrue a bunch of college debt … It’s unbelievable the debt that people have accumulated earning their degrees.

  18. Nicely stated. I’m from the school of thought that believes there is no such thing as ‘good’ debt. However, I would agree that some debt is not as bad, as onerous, as other types of debt.

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