Is There Such A Thing As Good Debt?

Good Debt

I confess at the outset that the phrase “good debt” sounds like an oxymoron to me.

Because I view “debt” with great negativity, attaching the word “good” to it doesn’t quite resonate. I also confess that I am not sure that I can be absolutely objective in answering the “good debt” issue because “good” and “debt” are subjective terms. Good to one person might not be so good to another. And debt is viewed as desirable by some and a plague by others. I therefore followed the council of Mrs. Jack (my fourth grade school teacher)…I looked these two words up in the dictionary. Here is what I learned:

Good: Being positive or desirable in nature; not bad or poor
Debt: Something owed, such as money, goods, or services

If there is such a thing, therefore, as good debt, it could be defined as “owing something, such as money, goods or services, in a way that is positive or desirable” or “owing something in a manner that is desirable”.

With that definition set, I need to make one more stipulation: we will only consider debt from the “before” perspective. Many will be quick to point out a time when their debt turned out all right (after the fact) but, simply knowing that it went all right that one time does not classify the debt as good debt. With that logic, borrowing money to play a roulette wheel would be considered good debt IF you win.

OK. We have some parameters set. Now let’s examine a few different types of debt to see how they meet our definition.

Borrowing money to finance anything that is quickly consumed.

This is one of the worst possible debts. Why? Because, be it a hamburger or a vacation, you have nothing to show for the money your borrowed. Getting billed for something you no longer own is just not smart.

I see nothing desirable with this type of debt, so I am ruling it out.

Borrowing for a car.

I consider car debt better than borrowing for a vacation, but still problematic. Why? Because a car is a rapidly depreciating asset. Even those who stay current on their payments are commonly “upside down”, meaning that despite all their monthly payments, they have negative equity. Many people who stay in car debt their entire lives struggle to save and therefore approach retirement with little net worth.

Is there a time when car debt is desirable? Hmmm. If one absolutely needs a car to get to a job, there may be a need to borrow to buy this car. This might be considered “allowable” debt, but I couldn’t label it as positive or desirable in nature.

Borrowing for college.

Money borrowed for an education is often considered a good investment. Why? Because the education will pay dividends by providing a good job. While this does hold true in many cases, I need to point out the downside of educational debt: the risk factor. What do I mean? Simply that there is no guarantee that this debt will provide a job that will allow the debt to be paid off. According to Career Consultant Dan Miller, 80% of college graduates, 10 years after graduation, are not working in their field of study. And many students, after accumulating huge hunks of student debt, never graduate. Guess what? They still owe the money. To compound the problem, jobs are scarce for this age group: based on a CNN study, unemployment rates for ages 20-24 is 50% higher than the general population

Now the question: Is a Student Loan good debt? Remember our “before” stipulation: while the loan MAY work out fine, no one knows when borrowing the money if he will graduate or nab that great job. Because of the risk already mentioned, I have trouble thinking of the debt as desirable. College loans therefore flunk the “good debt” test.

Borrowing to invest.

The practice of leveraging OPM (Other People’s Money) in order to make money has been around for a long time. This would include debt for “flipping homes”. Financial gurus have taught for years that leveraging is sophisticated and “good debt”.

But is it? Again, the risk factor needs to be considered. What happens when the market plunges? For real estate investors, what happens when the bottom falls out of the housing market? The borrowed money still needs to be paid back and, with depreciated assets, there may be little or no cash flow to make the debt payments.

Granted, many do well with leveraged money, but, once again, because of the risk involved, this practice cannot qualify as owing in a desirable way.

Borrowing for a home.

Because most of us will realistically never save enough to pay cash for a house, and because homes have historically risen in value, nearly everyone agrees that home mortgage debt is “good debt”. However, some home debts is better than others. Why? Again it is the risk factor. Ask any of the millions who have been foreclosed on in recent years. Obviously there is no guarantee that one or both wage earners will not lose their jobs and there is no guarantee that the home value will always appreciate. When income is lost and the house can’t be sold for enough to pay off the loan, foreclosures occur. Therefore borrowing for a house should involve a number of safeguards to lower the risk: no other debt, three to six months of expenses set aside for emergencies, a good down payment and a loan of not more than 25% of family take home pay.

So, with these safeguards in place, would I consider a home mortgage to be “good debt”? I would say …. drum roll please …. Yes. When risk is minimized, borrowing to buy a home is a positive and desirable thing.

Conclusion

The factor that rules out “good debt” in nearly every scenario is the factor that is all too often overlooked: risk. People like to think that if they qualify for a loan, they should borrow the money. Not so. Lenders will qualify you but they are not obligated to explain the “what ifs” of debt. It is always the responsibility of the borrower to keep both eyes open and assess the risk.