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Good Debt versus Bad Debt

You see it, hear it and read it all over the place these days. America has too much debt, how did we get so far in debt or a more personal note, how do I get out of this debt. There’s no doubt that debt can be a very bad and sometimes even soul crushing thing for some of us. What I don’t see enough of is the distinction being made between good debt versus bad debt.

That’s right, some debt can actually be good for you. Before you go grab the latest pre-approved credit card offer from your trash can or run down to your bank to get a loan, read on.

There are some things that provide enough value back to us that racking up debt to get them makes good financial sense. Our homes, a car to get to and from work and a college education are some examples of things the most people would never be able to buy with cash.

A home provides us with shelter, a sense of security and even increases in value by historical standards. Home loans are typically at a low interest rate and mortgage interest is tax deductible for most people. Using debt to purchase a home is usually a pretty good investment.

A car is almost necessary in some areas to get to and from work. Not having one can limit our job prospects and make it difficult to do the simplest tasks, such as grocery shopping. If you don’t have easy access to public transportation then financing a car can make good financial sense too. It is one debt that you should try to pay off as quickly as possible though as the return on your investment for a car is usually negative.

A college education will pay you back for the rest of your life and could be argued to be the best investment of the three. College graduates with a Bachelors degree will make $900,000 more than those with a high school diploma on average during their lifetime. Those with a Masters degree are likely to make $1.3 million more than their peers with only a high school diploma. Pretty heady stuff that. Combine that with low interest rates, payment deferral and tax breaks on student loan interest and I think you’ll agree that using credit to get a college education is a pretty financially savvy move.

That being said, we still need to make wise choices when we start to take on even good debt. Going beyond your means is not a smart idea. What I mean is that there is no need to buy a $250,000 house when you’re only making $40,000 a year. In the same vein, a $20,000 car will get you to work just as well as a $40,000 car. And an Ivy League education is not necessary to increase your income, in most cases your State school will be the best value for your money.

In almost every case you can determine how “good” a debt will be for you by looking at how it will enhance your lifestyle on a permanent basis or at least in the long term. So, a new pair of shoes might make you feel great today and maybe even for the next couple weeks, but they provide no long term improvement in your lifestyle. Paying a 12-24% premium for them (in the form of credit card interest) is a poor financial choice. The same applies to a pepperoni pizza, new clothes, a night out partying with your friends…I think you get the picture.

Taking on good debt and avoiding bad debt is all part of managing your money. When you are able to control the things that are adding to your debt you are in control of your money and will find that there’s a big difference in the quality of your life when you are in control.

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