There is No Good Debt

In his newest book, Debt Free For Life: The Finish Rich Plan for Financial Freedom, author David Bach shares the following about how he responded when someone asked him about "good debt" versus "bad debt":

Almost automatically, I started giving her the standard answer about how good debts are generally considered to be debts you incur to buy things that can go up in value—like a home or a college education—while bad debts are things like credit card balances, where you’ve borrowed money to buy things that will depreciate or go down in value, like most consumer goods. But then I stopped in mid-answer and looked at her.

“You know something?” I said. “The truth is that this recession has changed everything. Homes are going down in value and people with college degrees are looking for jobs. Forget what I was just telling you. Forget about the idea of ‘good debt’ and ‘bad debt.’ Th e truth is that when you’re in debt, it doesn’t matter what you’ve borrowed the money for. The only thing that matters is whether or not you can afford to pay it back. And if you can’t, all debt is bad debt.”

He follows this up with what he calls the best investment you can make now:

The best investment you can make over the next five years is going to be paying off your debts. So my advice is to pay off what you owe as fast as you can. The faster you pay off your debt, the faster you will achieve financial freedom.

Welcome to the light side, David. ;-)

Ok, so it's not that clear what "good debt" and "bad debt" are these days. But the usual "no brainers" of college loans, mortgages, and borrowing for business now have a long list of caveats that make them less compelling than ever. It's likely these caveats always existed (like don't borrow too much for college unless your post-grad earnings justify it), but most people just never needed them. Today, borrowing is so out of whack, even for "good debt", that every type of debt needs to be considered and weighed carefully -- or else it could sink your finances.

Being too deep in debt is #3 on my list of 10 worst money moves anyone can make because it can cost you a fortune (for example, here's why it's a bad idea to make the minimum payment on a credit card.) IMO, the less debt people have, the better. That's why I've been debt free -- completely debt free -- for over a decade.

If you want to be debt free too, here are seven steps to get out of debt along with some real-life stories of how others became debt free.

I know I'll get some comments that will argue in favor of debt and "leverage", especially from real estate investors. I'm not saying that debt is bad in every circumstance. (There's a situation in which almost any financial move makes sense even though it doesn't in the vast majority of cases.) What I am saying is that there are very few people who can manage and deal with debt in a productive manner -- to the point where the debt works for them instead of vice versa. Even people who go into a situation trying to use debt as a benefit, often come out being burned. So the odds are that most people raeding this are not using debt, but being used by it. And that's seriously dangerous to your financial health.

Comments

[Matt]

I like the idea of debt is debt. There is nothing good or bad about it.

The sooner you understand that the better off you will be.

Paying down debt is good, going into too much debt is bad.

You need to be your own judge of the how much debt you can afford and not the bank.

[JimL]

I was previously in the camp of mortgage debt being good debt. I no longer have that opinion. We have enough in short term savings to payy off the mortggage and I am compelled to do so. I just hate seeing the savings balance going down that low.

[Bogey]

I am slowly but surely getting this through my head. I just wrote a post on my blog last night talking about how much cash we should keep on hand, and my tendencies to hoard cash. Inherently I know it would be better to start paying down my wife's car loan and out mortgage, but it sure is tough to let that cash go!

I am still in the camp that favors lump sum debt repayment (at least for secured debts - credit cards are another story).

I think people's ideas about debt have definitely changed over the past 2 or 3 years, but it won't really matter if the beliefs aren't carried forward once the economy starts booming again. We typically make the same mistakes over and over.

[slug]

When everyone else is de-leveraging and building up stockpiles of cash, I start to think that now's a great time to seek leverage and use it for the right investments. And yes, right now, I'm looking at buying my first rental property. To each his own though.

[indio]

If you lose your job or you're sick and can't work, there is no such thing as "good" debt hanging over your wallet. I used to view mortgage debt as good debt because my money could perform better in the stock market, but that isn't a guarantee, as we all learned in 2001 and 2008.

[kitty]

@Slug - exactly. I don't look for it at the moment, but the article is very simplistic.

Taking a loan to buy a home or to get an education or open a business is a type of an investment decision. Even for a home - yes it's debt, one would have payments, but when one pays rent, one also makes payments every month and these payments go up. They issue is - which would be better in a long run.

Similarly education - why everyone generalizes here? Taking a loan to get a philosophy degree isn't the same as getting a loan to got to medical school.

If I go to buy a car, I have cash. But if someone offers me 0% loan, you bet I'll take it. I'd simply put money in a high yield savings instead.

Any investment decision can be good or bad.

[SM]

IMO, any debt which extracts interest at a rate that is lower than that I can get by keeping money in a "safe, guaranteed rate" investment vehicle (savings, checking, CDs) is a no-brainer good debt.

Couple of examples:
1. 0% APR credit card offers are almost always good debt (subject to balance transfer fees).
2. Low interest loans (say Car loan at 0.9%) where APR is lower than savings/CD rates (say 2%).

I went to buy a car expecting to pay cash. Toyota was running a 5 year 0% offer. I grabbed it. I would have grabbed it as long as the loan APR was less than, say, 1% because I am better off with that money sitting in a 1.5% CD.

[jeffinwesternwa]

most folks who HAVE debt simply try to rationalize it, vice the obvious! Spend less, work more, develop NEW habits and attitude and pay it OFF!

[SteveD]

I bought three rental properties last year, all with mortgages, and I'm looking to buy one more now. The rental income more than covers the mortgage and all expenses. For the same amount of cash, I could have bought one house mortgage-free. Yes, I'd have more cash flow today with 1 house and no mortgages, but in 30 years (at retirement age) I will have 4x the cash flow and 4x the equity. I am very happy with my debt choice! That said, I do plan to pay down the mortgages when house prices go back up, and retire much earlier than 30 years from now. But I suspect that future-me will thank me for taking the risk to invest heavily when the market is down!

Another example: I also think that paying $500 in interest to a bank (which decreases with time) is better than paying $500 to rent (which increases with time), for those people who can't afford the full price of buying their own home. The problems arise for people who have too much debt and buy more than they can afford.

[Jani]

as long as your investment of debt money appreciated (principal + interest) over a period, it could be a 'Good' debt, but like said, now a days, no Guarantee (Real estate / Stock Mkt. or you name it), so yeah, there is no such thing as 'Good' debt

[Andrea]

This economy is teaching me to pay off my debts, and not create anymore. I've seen many people who made investments in real estate a few years ago because they thought their properties would be worth something.

Now because of the economy, many have lost their jobs, and their properties are worth less then what they paid for. But I also see this as a buying opportunity for someone looking to invest.

[Old Limey]

Once again - Timing is Everything!

I borrowed $20,000 at 4.25% in 1963 to buy a home for $26,950.
In 1977 I sold it for $90,000 and traded up by borrowing $43,000 at 4.75% to buy a much nicer home for $107,000.

Without acquiring this debt when I did I would not have lived in a prestigious neighborhood of beautiful well kept up homes for the last 33 years and instead would still be a renter, living in a much less desirable location. By going into debt I now own a home, which was paid off in 1992, and is now appraised at just under $1M. I consider that to be an excellent use of debt.

Contemporaries of mine, instead of investing in the market, used debt to invest in rental properties which also turned out to be both great investments and a nice source of retirement income.

At the end of WWII the homecoming G.I.'s were able to get low interest rate VA loans with nothing down, in a program that turned out to be equally as successful as the G.I. Bill of 1944, considered to be the most successful piece of legislation of all time, that helped so many returning veterans to get the college degrees that they missed out on when they were called on to serve their country.

Unfortunately the "Ownership Society" promoted by the previous president turned out to be a disaster because of the housing bubble brought on by the proliferation of many thousands of sub-prime loans made by greedy banks and mortgage companies to very under-qualified buyers.

[Robert]

The Credit Fairy says there's a contest being held where people are shredding their credit cards. That's definitely one way to stop debt; not get into it!

[kitty]

@jeffinwesternwa "most folks who HAVE debt simply try to rationalize it, vice the obvious! Spend less, work more, develop NEW habits and attitude and pay it OFF!"

Have you considered that people above who posted about different ways to leverage debt might have higher net worth than you do? Maybe we don't really have debt or could pay it off tomorrow if we wanted? Leverage has been a well known way to make money.

For example, those of us who said that we'd take a loan if the interest rate is better than a return in savings clearly mentioned that we do have cash to buy a new car, but would CHOOSE to take a loan if the interest rate is lower that what OUR MONEY earn in fixed income investments.

Similarly in terms of housing - and for the record, I have no mortgage - people who talk about saving and buying home for cash seem to forget that they pay rent every month and that over 30 years they may end up paying more in rent than someone with a mortgage.

[Mark]

I think the underlying thought process here is that all-or-nothing thinking always has limitations. You really have to be able to think for yourself when it comes to these kinds of decisions. That means you also have to know yourself and have realistic expectations about future prospects. Unfortunately, most people are bad at self evaluation, which is why we are in the mess we're in.