Is All Debt Bad?

Best Money Borrowed

A few weeks ago, I wrote about the best $8,000 I ever borrowed. That is one loan that has continued to pay dividends 10 years later. After reading some of the comment for that post I started thinking if all debt is bad?

Good Debt (The Traditional Definition)

I first heard the term “good debt” when I read the book Rich Dad Poor Dad by Robert Kiyosaki. This is largely because it was the first personal finance book I ever read. The two main takeaways I remember from the book are the importance of passive income and good debt vs. bad debt.

In a nutshell, good debt can be classified as any type of loan that can improve your future financial health.

Two common examples of “good debt” include student loans and a home mortgage.

Student Loans

We go to college and borrow tens of thousands of dollars so we can make hundreds of thousands of dollars more than the average high school graduate who may or may not go to technical school for advanced training. One thing I re

One thing I remember from high school was the guidance counselors showing us graphs once a year on how much more college graduates make in a lifetime compared to non-college grads.

See my message to graduating high schoolers, Why Millennials Have College All Wrong, for more insights on planning for college. And read my Commencement Address to the Graduating College Class of 2017 to find out how today’s college students can maximize their degree.

Home Mortgage

Another form of “good debt” is buying a home.  A monthly mortgage payment can be cheaper than a monthly rent payment and you build equity with each payment. But, you also become the handyman and chief maintenance officer when you put your name on the dotted line at the title agency.

When I still rented, my monthly payment was close to $800 a month for a one bedroom apartment. A 30-year mortgage would have been about $500 to $600 for a small house. People at work always told me renting was futile as you are only paying somebody else’s mortgage payment.

Investments

A third form of “good debt” is borrowing money to invest. There is a lot more market risk as no investment is guaranteed to profit, but, if you have a hunch where the next shopping center or housing development is going to pop up overnight or even what stock will be the next Microsoft or Google, you can make a killing.

This form of debt might be better for the market experts whose livelihood depends making profitable investments. One “investment” the average Joe can make money is with rental properties.

Bad Debt (The Traditional Definition)

Is all debt bad?

Bad debt (obviously) is the opposite of “good debt.” This is debt that most likely will not generate passive income or boost your earning potential.

Car Loans

Cars are depreciating assets from the moment they leave the factory floor. We need cars to go to work, drop the children off at school, and run errands. But, do you really need a brand-new $50,000 one with 0% financing for 84 months?

Or, can you buy a used one with cash for $5,000, $12,000, or even $20,000?

I have no regrets borrowing money to buy my dream car, but, besides helping impress my wife when we first started dating (one huge benefit), any old car would have gotten me where I needed to go.

Furniture and Electronics

Have you ever borrowed money with interest to buy a new living room set or tv? Even at 0% financing, these purchases could still be considered bad debt because you still have a monthly payment.

It depends on how extreme you are about borrowing money. For the most part, if you can save up and buy a couch our tv with cash in the bank, you are better off because it’s one less chance of missing a payment and getting charged a fee.

Vacations

Vacations are a time to relax. Borrowing money to go to Hawaii or an all-inclusive Caribbean cruise is enviable and will get your mind off of life for a week, but, then you are stuck paying for it for the next couple months.

Borrowing money for pleasure is almost always a form of bad debt.

Why All Debt Is Bad

Is All Debt Bad

Here is one reason all debt is bad. Monthly Payments.

Monthly Payments

My wife and I still budget with pen and paper and every few months we write down our expenses.

Our largest expense right now is our home mortgage payment. We dislike (hate) it so much, we want it paid off early. We are on track to repay our 15-year mortgage in 5 years at our current pace. Lord willing, we will accomplish that goal in four more years.

While some people consider a home loan to be good debt, the monthly payments stink. For starters, it means my wife and I need to make that much more extra money each month to afford the monthly payment. If our minimum monthly living expenses are $1500 (mortgage, utilities, food, insurance, and other loan payments, etc.), then we need to make at least $1,501 to not go into debt.

One memory I have from car shopping was almost every salesman talked about how low my monthly payment will be. My general rule of thumb is that if it’s a common sales tactic, you need to look to see who the wizard is behind the curtain. It’s so common because it’s effective because we all think everything is fine if we can afford another monthly payment.

Interest

Another reason to dislike debt is interest payments. 0% financing loans are really nice when you can get them because you pay the same price as if you had paid in full. Paying interest adds to the overall cost which means more monthly payments and the fact that you are paying interest on a depreciating asset for consumer purchases like cars, furniture, and electronics.

Our Culture Praises Debt

Don’t get me wrong, I love living in the modern Western world where we have disposable incomes, vacations, gadgets, and being able to buy anything I want on the Internet at 3 a.m. and have it delivered to my doorstep.

What I don’t like is that our consumer culture makes it feel as if you need to be spending money on something all the time. I don’t need a new cell phone every two years, a new car every three years, or even to go to Disney every year. If we don’t spend money, the economy will collapse goes to the common logic.

Although, I got to hand it to the marketing firms. They are very effective at what they do and I admire their skill.

Debt Is Our Own Choice

If you want to go to Disney each summer or upgrade to the newest Apple device, that’s cool, if you can afford it.

Any essential expense can be as expensive as you want it. We all want a Mercedes-Benz with a red bow for Christmas, the McMansion with an inground pool, or upsizing our fast food meal because it’s only 99 cents more.

“Good debt” can quickly turn into bad debt when we buy too big of a house, the real estate development falls through, or we choose to get an expensive college degree for a career field with small salaries. Nobody can predict the future, but, we can talk to our friends and family plus some spiritual reflection to help make informed decisions.

“Bad debt” can turn into “Really bad debt” when you overextend yourself financially. One too many loans can be the figurative straw that breaks the camel’s back.

Should You Borrow Money?

Me and my wife are currently in debt with a home mortgage, so I’m obviously not totally opposed to borrowing. But, I think there are six questions you should ask before you borrow?

  • Can my emergency fund cover at least three months of living expenses?
  • Do I really need this purchase?
  • Can I buy it with cash? (Not your emergency fund)
  • Can I afford the new monthly payment?
  • Will a down payment get a lower interest rate?
  • How else can I spend the money if I don’t borrow the money?

When It’s Ok To Borrow Money

While I think any form of debt is bad, we are blessed to live in a country where we have the economic mobility to borrow money and eventually pay it back.

If you have a plan and have answered the six questions listed above, here are a few times I think it’s okay to go into debt.

House

I personally don’t include my house in our net worth (even once it’s paid for) because we live in it. It’s not an investment. We hope to pass it down to our children as a legacy.

Buying a house is also good if you plan to live somewhere long-term. Private property is one blessing of wealth that so many of us enjoy in America that others cannot imagine. If you pay rent, the landlord can kick you out if they want to sell the property to a developer that has other intentions for the land.

Tip: If you plan to buy a house, save and put down at 20% to avoid PMI. Also, try for a 15-year mortgage instead of a 30-year loan to save thousands in interest payments.

And, just because a bank says you qualify for a $500,000 house doesn’t mean you need to buy a house that expensive. Banks will still remain in business if you buy something for $250,000.

Bonus Tip: Because mortgage interest is so cheap, many borrowers will make the minimum payment on their home loan and invest the extra money because you can get a better rate of return long-term. While you will pay more in mortgage interest an average return rate of 8% with investing will still outperform a 3.25% mortgage. If you are comfortable with having a home loan the full 15 or 30 years, this option can also be financially lucrative.

College

Personally, I think the traditional 4-year college degree and immediately going to graduate school is overemphasized. The result is an abundance of overeducated adults working entry-level jobs with salaries that haven’t kept pace with tuition inflation.

I went to school for Political Science because it sounded cool and only needed a generic degree for my original career ambitions and I finally began using part of my education eight years after I graduated. My wife also got a degree just to get a degree to keep future doors open even though she planned on being a stay-at-home mom (thankfully she didn’t have student loans).

We tell the teenagers and their parents that it’s okay to go to technical school if you want a “hands-on” career like being a mechanic, electrician, etc. There are several members in our family without a bachelor’s degree that make more money than us because they have technical skills us profession folk never learned wish we did. Having a little entrepreneurial spirit also helps.  It goes to show, not every teen that says no to college is a slacker.

Tip: Look into state programs that can help reduce the cost of college or look at alternative ways to earn college credit like Dual Enrollment classes or CLEP. Also, consider going to colleges that have less name recognition if you can get more scholarship money. At the end of the day, you have a degree.

Rental Properties

For the average Joe, I think rental properties can be a good way to make a side income. If you can be firm with your tenants, aren’t afraid to perform maintenance, and have some extra cash to cover a mortgage, being a landlord can be very rewarding.

This path of passive income isn’t for everybody, but, I think it is a safer bet than borrowing money hoping to pick the next Google or Microsoft stock that makes all the early investors millionaires.

Tip: Consider getting a duplex for your first rental property and have the monthly payment for one side be your entire monthly mortgage payment. That way you always “break even” when one side is vacant.

Summary

I think debt should be an option of last resort for every household. It is almost impossible to not borrow some amount of money to attend college or buy a house, but, there are smarter and cheaper ways even to not borrow as much for these. Sometimes not going into debt means delayed gratification. It’s a weird withdrawal feeling at first when you used to it, but, you will soon discover that the lack of stress of having to be able to afford yet another large monthly payment can be worth the tradeoff.

 

 

 

 

 

 

 

8 Comments on "Is All Debt Bad?"

  1. I disagree with you on this. I think there absolutely is “good” debt that if leveraged properly can help you be much better off financially. Our mortgage has a 3.25% interest rate and I’m so glad we have invested the past six years instead of putting extra towards the mortgage. I think the same thing about our student loans that are low interest. If I had put extra money towards them instead of investing the past five years I would be worse off financially than today.

    • There are two sides to the mortgage vs. investing where you are either on one side or the other. Our mortgage rate is also 3.25% and my wife & I have contemplated this very issue several times because the math says you will have more money long-term by investing the extra money and continuing to only make the minimum mortgage payment with such low interest rates.

      For us, we both would rather have the debt paid off early to give us more flexibility short-term. Part of the reasoning is with our current employment situation and having a young family, the fewer bills the better. We are contributing monthly to our retirement and non-retirement investment accounts and we plan to begin making extra contributions once we repay our mortgage.

      I have also added a “Bonus Tip” in the Housing section to help explain this concept.

  2. I agree that it seems infeasible for most to pay cash for college or house, but saying that’s “good” or even just acceptable debt can be a slippery slope to not getting in more debt than necessary. And there’s always the danger of following the norm rather than exploring options and alternatives. For example, a mortgage might not be a bad idea, but a huge mortgage probably is “bad debt” if it’s going to seriously limit your options. Same goes for going to a pricey university vs. a more affordable one.

    • Going into debt can quickly become a slippery slope if you don’t set a realistic borrowing limit and “doing what everybody else does” when it comes to financing. Two great points.

  3. “‘Good debt’ can quickly turn into bad debt…” I’m glad you added this. I agree with Kalie’s “slippery slope” comment. Perhaps it’s better to see the mortgage as a “reasonable risk” rather than a “good debt”? For us, my husband’s business debt was a reasonable risk. It allowed him to start a second career (since we hadn’t been wise enough to set ourselves up to do that). He paid it off at warp speed though. It no longer sucks up any of our energy, work, or finances – which all debt does. Sounds like you’re doing the same with your mortgage. Smart, smart move!

    • The slippery slope is a good way to look at debt. Many of us like to think of things as being black or white. In reality, there’s a lot of gray in life. Debt is no exception. It’s a part of life, but, it doesn’t mean we automatically have to be irresponsible about it.

      We are taking the “Gazelle Intensity” approach to our mortgage payments.

  4. Our mortgage payment is our biggest monthly expenses. We could certainly build much more wealth without it, but for the past 19 years, we have had a stable living environment for our family to grow up, go to school, build friendships, etc. I’m not inclined to call it a bad debt. Would I do things differently, buy smaller, or less overall cost if I had to do it again. I’m sure. It varies per personal situation. I do agree to avoid debt when every possible is the best approach and doing whatever it takes to make that happen.

    • When we took out our mortgage, we tried to use as much cash as possible to keep our borrowed balance as low as possible. And, we made sure we didn’t build too large of a house or have all the fancy amenities that would have required to borrow more money.

      If our financial situation takes a negative turn, we will stop making as large of an extra payment. The good news of having a 15-year or 30-year mortgage is that you have that long to make the payment if you need that much time.

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