Not all debt is bad. Debt is generally okay whenever it is used to buy something that may increase in value. For example, going into debt can make perfect sense when you’re trying to start a business, or expand an existing one. Very few people can save enough cash to buy a home in a realistic amount of time without a home loan either. And an education loan can be considered good debt too — assuming you choose the right career path.
The bottom line: If you’re not careful, avoiding debt just for the sake of it may lead to missed opportunities.
Photo Credit: Jay Tamboli
Debt is an accelerant, allowing both higher highs, and lower lows. Hmmm, that could also describe most illegal drugs too. 🙂
A friend of mine has relatives running an apple farm in Amish territory in Pennsylvania. While not Amish themselves, they have always followed the basic Amish tenant of never borrowing money.
One year there was a big push to encourage (non-Amish) farmers in the area to borrow and expand their planting for increased profit. Those that borrowed indeed made more money that year. The next year saw even more borrowing… but then market prices crashed. Most of the farmers who borrowed went out of business. My friend’s relatives weathered the bad year just fine, as did the Amish farmers.
So there’s the trade-off. Increased risk for increased reward if you are successful, or increased financial damage if you are not. I guess it all depends on how much risk one is willing to accept. One person’s missed opportunity is another’s risk-avoidance.
I agree, DC. But there are ways to help minimize those risks too. Before agreeing to take on “good” debt for business reasons, for example, one can (and should) do at least a first-order market analysis to see if the proposed investment makes sense.
Or when taking out a school loan, one should do a little comparison shopping of schools and job market research to help evaluate the likely long-term return on investment that the education would provide.
a person needs to determine the intrinsic value of something as well as the extrinsic value to make a good determination of whether debt is good or bad.
Debt can be a good thing if used responsibly. It is when people take out excess debt for wasteful purposes that trouble occurs – think cash-out refi’s to buy a new plasma TV!
Good points. To add another caution, Robert, it also doesn’t make a lot of sense to take out “good” debt if one is already over-extended and unable to make the payments.
Debt is never a good thing)) Work more and have no debts! Thank me later))
Agreed. Building wealth incorporates leveraging your money. People instinctively shudder at the word “leverage”, but it just means using interest rates in your favor. Borrow money at 3% and collect it at 4%, and you can’t help but build wealth. Truly rich people don’t rely on salaries and wages to see them through.
By the way, today’s post was 101 words.
“Truly rich people dont rely on salaries and wages to see them through.”
Boy, ain’t that the truth! If I had to do it all over again, I would have gone into business for myself, Greg. A little scarier, but worth it in the long run.
As for 101 words: I guess I need to do a better job counting!
I think of the three types of “good” debt listed, most people can get by without any need for education debt if they really wanted to. I think starting a business without a loan is difficult but not impossible. As for buying a home — I think most first-time home buyers who don’t want to live rent free with their parents for 10 to 20 years have little chance of ever saving enough money to buy a house entirely with cash.
Assuming that parents are unable or unwilling to help with college expenses, how do you think students can avoid educational debt (other than by not going to college)? The total cost of attendance at many in-state schools is approaching $30,000 per year and scholarships are increasingly being allocated based on need rather than merit.
For example, my sister-in-law graduated as the valedictorian at her high school and had a decent SAT score, and yet was only offered small scholarships at the in-state public schools. Similarly, I attended an in-state public school, recieved a small scholarship and need-based grant money, worked during the summer and part-time in college and yet still ended up with $20k in debt.
This isn’t to say that our educational debt wasn’t worth it (it was and we both have no debt and good jobs), but it’s becoming increasingly difficult to not have any educational debt given the rise in college expenses (driven, in my opinion, primarily by guaranteed student loans covering the cost of attendence, which, in turn drives up the price of an education).
You’re right, Sean. Colleges are pricing themselves out of business. These days, if you’re going to take out college debt, it really should only be for a STEM (Science, Technology, Engineering or Math), medical, or law degree. Otherwise, the ROI probably won’t be worth it.
I managed to get my BS degree in a STEM major. I did not accrue any debt.
This is how I did it:
1. I went to a community college for the first 5 semesters. I took every course I could that would transfer to the university before going to the university. My youngest daughter is now doing the same thing. Her last semester cost me under 2 grand, books included. She is now a sophmore and lives at home.
2. I then went to the university for 3 semesters. Yep, 3 semesters because I took a full load, right up to 21 credits per semester. At 22 credits per semester, the cost went up significantly. I was able finish in 3 semesters, instead of 4. My youngest is going to do the same thing. Right now, costs are about $5K per semester (mine was 4K per semester 13 years ago).
Total cost of my daughters education for four years, books included: $30 grand total.
I am paying half of it with cash. She is paying the other half of it with cash from her part time job that she has now had for 3 years.
To spend $30 grand a year is not necessary.
Do I regret that I went to community college and a state school? Nope, not one bit. 13 years later none of my employers care where I got my degree, and I make in excess of $100 grand a year.
Choose wisely for a college education.
Well said, Spedie! As one who evaluates potential engineers myself for jobs, I can honestly say where they went to school makes little difference — at the end of the day, it’s only the degree that matters. The price premium students pay for more prestigious schools really isn’t worth it. In fact, when it comes to getting a job, any prestige that’s attained for paying that premium depreciates faster than a new car that is driven off the lot. In fact, the longer one is employed, and the more real-world experience that is attained, the university attended becomes irrelevant.
So very true!
The point about the correct kind of debt is very important! Debt to go to Disney isn’t the same type of debt as to try and start a business that has potential or to purchase rental properties, etc.
Your 100 words nailed the point, nice job!
I agree Len, when used properly, debt can help you accumulate wealth. I’ve got a very low interest rate on my mortgage and wouldn’t dream of paying it off early. I can use that same money elsewhere and get a higher rate of return (or least I have been so far….hopefully that will continue 🙂 ).
I guess great minds think alike, Geoff! 😉
You certainly can get a higher rate of return than simply paying off the mortgage. But answer me this, what price can you assign the wonderful feeling of a paid off mortgage? What price the feeling of independence, knowing you can switch jobs by choice? I’ve been mortgage free for well over 25 years. It allowed me to walk into my Credit Union and obtain a simple no collateral loan to buy some property. I then sold the house about a year later, paid off the loan, and used the excess funds to buy more property. 30 years ago I decided to return to school and finish a degree. It was only possible because I had no mortgage payment. It also allowed me to retire in my fifties.
If you have ever been through tough times, say the early ’80s when my mortgage rate term rolled from 7% to 18% overnight, was laid off from my job with an at home wife and two month old daughter, and had to work away in 3 month stints…….in short you never forget it. Ever. I was just 24 when all that happened. When I retired I woke up one day and said this would be really good time to pull the pin. Retire while my wife and I are both healthy and I still like my job. We now live on riverfront (that property I bought 25 years ago). I built a cottage on the extra property and the rent pays for all taxes and insurance while the tenant gets a great deal. I’m now shopping around for a skid steer tractor and will pay cash, the money saved every month from not paying a mortgage.
Times have changed. What used to be a good investment like buying a home is questionable now. Monthly mortgage was not considered debt per say but a way of increasing your assets and net worth.
Great post!!! As for the good debt bad debt issue, I think the trap is when people fall into the “I want it now” trap and finance things like furnature, applances etc. thinking I can pay it off in no time but then we forget about what they owe already and then go out and make another purchase because the interest is so low. Then before you know it you are living paycheck to paycheck and then an emergency happens and we fall back on Credit cards.
We just paid off our credit card debt and I feel a bit like someone who is recovering from an addiction – so scared to use them at all and risk getting back into trouble. However we are helping our daughter with some student loans and feel that is a wise decision for her future.
Truth be told, very few can save up enough for say a home or even a business. And while you can grow a business organically, its a rather slow process one which a bit of debt can help with.
As someone has pointed out, debt starts becoming dangerous when we misuse the funds for say, buying unnecessary consumer goods or financing an ostentatious life. If used responsibly though, it can catapult one right into financial independence and freedom.
Debt at today’s interest rates on a long fixed home loan could be a huge windfall down the road. Of course, never take out more debt than you can afford!
I don’t think any debt is good. Sure, there’s one thing to grow a business or invest in your education and there’s something else to buy clothing and go travel on debt. The RISKS are the same, no matter why you take the money for. Anything can be paid off with cash, as long as you’re willing to save for it. I have started a business myself and didn’t need any money to be borrowed. As soon as my business picked off, my husband started his and I was able to help him get a footing. Sure, we could have borrowed the money, but if the businesses didn’t work, we’d be in deep trouble. His business is slowly giving returns after 12 months, but we were not stressed, since mine was covering easily everything needed. And, the moment his is bringing in money, we have more to save.
Debt is usually used wisely to finance an asset which will increase in value.
It can also be used on the other side of the balance sheet to prevent decrease in the value of an asset already held.
For example, you can lend yourself your own savings and, in
effect, pay yourself the inflation rate on your savings as they would
deflate otherwise.
So, we bought a new car to replace a 19-year-old vehicle that died. Taking advantage of automaker’s well-nigh panic mode incentives not seen since the crash of 2007, we financed the car at zero percent for four years. We could have paid cash but instead chose to commit some of our saving at today’s value to future payments.
I agree, but I don’t think a zero percent loan really qualifies as debt, especially if you paid a fair price for the car. I think what you are doing is smart money management.
You’re going to pay back the same amount you borrowed in inflated dollars, even though we keep hearing there’s no inflation. That’s the same reason a long-term mortgage makes sense, providing you get a decent rate.