good debt

Good Debt vs. Bad Debt

July 11, 2016 By Jennifer Clark 2 Comments

When we hear the word “debt,” we all cringe a little bit but, really, not all debt is bad.

Articles consistently flood the internet on ways to get out of debt, including right here on SavingAdvice.com, so how could any of it be good if we are always trying to get rid of it? Alternatively, many try to avoid it completely in the hopes of never having to worry about looming financial obligations. The fact of the matter is we need debt sometimes in order to build ourselves financially. Familiarizing yourself with the difference between good and bad debt is a better route than trying to hide from it entirely.

So, how do we tell the difference?

What is Bad Debt

Let’s start with the bad news.

To simplify the term, bad debt is essentially items you purchase with a loan or borrowed money that accrues interest that depreciate in value. Basically, if you go into debt for an item that won’t create income or does not go up in value, that is bad debt. It may be advised to avoid this debt at all costs, but we all know that may not be feasible.

Examples of bad debt include:

Credit cards. Credit cards tend to have significantly higher interest rates than consumer loans. By not paying off your monthly balance on your credit card, you end up paying more than the cost of the original item. This is especially true if you use credit cards to pay for things such as vacations, clothes and food.
Cars. The minute you drive a vehicle off the lot, it loses value. Even as you maintain it throughout the next few years following the purchase, it depreciates in value, developing a lower value than what you originally paid for it (plus interest). The cost of your car ends up being a loss by the end of it, which is why this falls under the category of bad debt. If you have a strong credit and are able to pay for a car out of pocket with cash, it is recommended to do so to get a bigger bang for your buck.

What is Good Debt?

Now, let’s move forward to what makes up or defines good debt. This positive side of financial obligations should help you build wealth, not take away from it as bad debt tends to do. With good debt, you are using money to make money, which helps to improve your overall net worth.

Examples of good debt include:

College or higher education loans. Those with a higher education or more likely to obtain employment, whether it be a four-year college program or training at a technical school. More opportunities exist with such an investment, even if it is not within your field of study. The money put into advanced knowledge like this is more likely to provide you with an ongoing source of income to tackle the debt accumulated.
Real estate. While homes and properties do still tend to depreciate in value over the years, the investments placed in real estate are more likely to turn over a profit than that of say a car. Circumstances exist that allow you to collect money on properties as well such as renting out space. Because of this, real estate falls more under good debt than bad.
Investments. Whether choosing to invest in stocks, bonds or the like, investing does take some initial funds in order to get started. Despite the risk and lack of guarantees, you do have a greater chance of achieving a return on investment. A variety of options exist for beginners to the more advanced investor as well. Consulting with a financial adviser will help to lead you in the right direction.

Some may argue that all debt is bad, but as you can see, some is needed to build credibility as well as get by daily in our lives. Being choosy and wiser about which debt you take under your belt will help keep you out of trouble longer. Learning how to differentiate between good and bad debt creates more stability for your bank account. Having bad debt won’t put you so far under necessarily, but it easily can. It’s as the old saying goes, “everything in moderation.”

Do you think you hold more good debt or bad debt? What steps are you taking to get out of debt?

Photo: Flickr: Christian Schnettelker

The Student Loan Myth

January 31, 2011 By Jennifer Derrick 7 Comments

For the past generation or so, lenders and financial gurus have been promoting the myth that all student loan debt should be considered Good Debt. Student loan debt is said to be good because it is debt accrued in the pursuit of an education, which is an asset that will (ideally) product more money. The theory goes that you will take out student loans, get your degree, and then get a job earning so much money that paying those loans back will be a piece of cake.

To some extent this isn’t bad thinking. An education is certainly an asset that will increase your earning power. However, the problem is that people have bought into this myth so entirely that they are coming out of even community colleges with hundreds of thousands in debt. Many people have bought into the notion of student loan debt being so good that they are even using student loans to pay everyday expenses, in addition to tuition and books. They’re getting apartments in the nicer complexes on student loans. They’re using student loans to finance entertainment and spring break trips. “Heck,” they think, “It’s student loan debt. It’s all good.”

Many people are financing educations at schools they couldn’t possibly hope to afford any other way. While there’s nothing wrong with wanting to get a degree from a prestigious university, you have to ask yourself if it’s worth it. In some fields like medicine and law, where you get the degree matters. And those fields will likely earn you enough money that paying the loans back will be feasible. But in many fields it doesn’t really matter at all. The cost of an education at an “affordable” state school is rising faster than the pace of inflation. That alone will set you back for years. Go to a private school for that degree in philosophy, rack up the debt in pursuit of a degree that won’t earn you any money, and you will be in the hole for the rest of your life.

Student loan debt isn’t good debt when it crushes all of your other hopes and dreams. When you’re so busy trying to make loan payments that you can’t afford a house, car, children, or even a pizza, you’re in trouble. And that’s just where some people who bought into the “all student loan debt is good debt” find themselves these days. Jobs are hard to come by. High paying jobs even more so. Student loans are some of the most forgiving in terms of repayment schedules, interest rates, and being willing to defer payments for a while, but even the most forgiving won’t wait forever to get their money back.

So while some student loan debt isn’t bad, you have to make sure you’re not crossing that threshold where good goes bad. What can you do?

Go to a college you can afford by taking on a moderate amount of debt: That may mean a state school, or going to community college for two years while you work to save up extra money. If it really matters where you get your degree, got to a cheaper school while you’re an undergrad and save the big loans for your graduate work. Graduate work will give you more earning power and is thus, “better debt” than that taken on for undergraduate work.

Work while you’re in school: A lot of kids still work while in school, but many don’t. Even a part time job can help offset some expenses. If you work full time during summer vacation and breaks, you can earn even more. Yes, it’s complicated and hard to juggle school and work (but it’s just as hard to juggle work and the rest of your life once you’re out of school), and it may mean reducing your course load and taking longer to graduate, but it’s better than owing hundreds of thousands of dollars when you get out.

Look for money that doesn’t have to be paid back: Instead of going straight for the loans, look for scholarships, grants, or work study programs. That kind of assistance doesn’t have to be paid back and there are programs for almost every field of study. Even small scholarships can help if you can string enough of them together. Too many people run straight for the loan officer instead of looking for other options first.

Get educated: Before you take out a loan, read all of the fine print and understand all the terms of the loan. Know when it has to be paid back and what your total payments will be. Understand how interest is calculated and what happens if you hit a rough patch and can’t make payments. Know everything you can about how that loan will affect your future before you sign. Too many people take out loans not understanding the full impact they will have on all the other things they want to do in life.

Live cheap: You want to live in the nice apartment complex and drive nice cars. And why not? Many people today (whether in school or not) have lifestyle expectations that are way out of whack with their means. When you’re in college and racking up student loans, this is not the time to blow it all on a lifestyle. This is the time to hunker down and make that money stretch as far as possible so you have to take out less and, eventually, pay back less. Live on campus, eat on campus or cook in your own kitchen, skip the expensive cell phones and gadgets, don’t take expensive spring break trips, wear old clothes, buy used books, and find any other way you can to live cheaply. You can pay for a lifestyle later when you’re earning the big bucks.

There’s always the military: Do your four-year hitch in the service and you can get on the GI Bill. Let Uncle Sam pay for your education in exchange for serving your country.

Choose a degree with earning potential: I don’t care how interested you are in philosophy, general liberal arts, or family and child development, those degrees aren’t money makers. If you’re taking on tons of debt that you need to pay back, you need a degree that will earn you money. That may mean majoring in science, computers, medicine, law, business, or some other emerging field that has high earning potential. Minor in your fun interests, but major in something that pays well.

Finish school: One of the most useless things you can do is to incur a ton of loan debt and then not finish the degree. Not only are you stuck paying on the debt, you don’t have the earning power to pay back the loans. Make sure you want to go to college in the first place and then, once you’re there, finish the program.

Student loan debt can be good, but too much of a good thing can derail the rest of your future. It’s fine to take on some student loan debt and it can be a useful tool to help you reach your aspirations. Just don’t let it get out of control. Paying off loans into your forties or fifties puts your other financial goals like retirement, saving for your own kids’ college, and buying a home in jeopardy. You want an education, not a dream-crushing debt load.

Going Into Debt to Have Kids

October 20, 2009 By Guest Writer 19 Comments

By Maggie Ellis

It is widely taught in financial education that there are only two kinds of debt that can be considered “good debt”: A mortgage and student loans (as long as they aren’t beyond your ability to repay comfortably). We’re always taught that it’s okay to go into debt to buy a house or another piece of real estate like a rental property because real estate is an appreciating asset. Generally you’ll get more when you sell than you paid. Similarly, student loans are a way to ensure you get an education that will (hopefully) increase your earning potential over time. The loan is an investment that should be worth more over time than you pay initially. Almost every financial guru and expert preaches that to go into debt for any other reason is a bad idea.

So imagine my surprise the other day when, while listening to Dave Ramsey’s program, I heard him tell a caller that it would be okay to go into debt in order to have kids. The caller was trying desperately to have children but was having no success the natural way. So she was calling Dave to ask if it was okay to go deeply into debt to either adopt, go through fertility treatments, or pay for a surrogate.

No matter which road she chose she would be looking at anywhere from $10,000 on upwards to $100,000, depending on the method. She didn’t have this kind of money just lying around and health insurance wasn’t going to cover fertility treatments. She confessed that they already had a lot of debt, including about $30K in car loans and $20K in credit cards, plus student loans and a mortgage. Her proposed method of covering her child-getting expenses was through a combination of home equity loans, private loans, and credit cards. They have no emergency fund, no savings, only about $5K in retirement, and no other assets. She asked Dave if she should take on the extra debt to have kids. His answer was yes, his reasoning being that children are such a blessing that they are worth it at any cost.

Now, I know Dave comes from a certain religious perspective that believes children are gifts from God, blessings, worth all sacrifice, etc. And I can respect that, to a point. But taking religion out of the equation and sticking strictly to the numbers, I wondered if it was really such a good idea to go so deeply into debt to have children. I see more than a few problems with saying yes.

First of all, if someone like this caller already has a large debt load, going deeper into the hole to have kids is only going to cause more problems down the road. Much of their income is already going to debt payments. They would likely be strapped already to afford the things a baby needs and adding to that debt burden is only going to make it more difficult. What happens when the child gets sick and needs medical attention that isn’t fully covered by insurance? More debt. What about college? There can be no college savings if all of the income is eaten up by debt. What about necessities? Even buying things used is going to add up to quite a bit of money. How will all of that be paid for when there is so much debt? Daycare? That’s only going to add to the financial stress and if all the income is needed for debt payments, no one can stay home with the child, either. Barring a huge increase in income, I just don’t see how such a debt load can be comfortably managed, especially factoring in the needs of a child. I can only see this couple ending up in a much deeper hole than they started in.

Second, if the caller goes the fertility treatment route, what happens if she gets multiples? Multiples are statistically more likely with fertility treatments. With an already crushing debt load, all of the problems I mentioned above would be multiplied by two or even more. Even for someone with no debt multiples can be an overwhelming financial burden. Buying two or more of everything in a very short time frame is expensive.

As for the risks to the parents, what happens to their retirement? There can be little to no saving for retirement when trying to pay down these kinds of debts. What about the house? Taking out an equity loan to pay for having kids puts the house in danger. If the parents lose a job and can’t make the payments, both they and the kids are homeless. How can the parents scrape together an emergency fund (and with kids you’re going to need one) or put away any kind of savings for a rainy day? I just don’t see how it would be possible under those conditions.

I think in the case of this caller Dave was wrong to give them the okay to go deeper into debt to have kids. He should have told them to get aggressive and pay down all of their other debt first. Get a second job and sock it all away in an emergency fund. Then, if they still wanted to go into more debt for kids, maybe it would be better. At least they wouldn’t have such a crushing debt load and they might have some savings to work with.

What about going into debt to have kids if you have no other debt? Would that be acceptable? I think it depends. Yes, children are a blessing, but perhaps not worth risking your own financial future over. If you had no other debt and were very disciplined about saving, paying more than the minimums, and earning a high income, maybe you could do it and not damage yourself financially. If you could still manage the debt repayments and still afford the child(ren) and take care of your own financial needs like retirement savings and emergency funds, then maybe you could handle $30,000 -$100,000 in debt without too much trouble.

I think that if you already have a lot of debt, adding to it to have kids doesn’t help you and it doesn’t help the kid who will have to grow up in a household burdened by debt and money stress. One lost job and the house of cards will come down. Get your financial house in order before taking on debt to have children. Pay off your existing debts. If at all possible, save like crazy, sell stuff, and cut out all non-necessities to save for the treatments/adoption and pay cash. If you have no debt, maybe you can manage more comfortably, but you still don’t want to take on more than you can comfortably repay.

No matter what, take emotion out of the equation. It’s very easy to get caught up in baby lust, envy of friends who have kids, and wannabe grandparents who are pressuring you. It’s easy to get to a place where you think you have to have kids or die. Sit down and take a cold look at the numbers before jumping into that kind of debt in order to have kids. You wouldn’t take on a large financial commitment like a house without thinking through the numbers; kids shouldn’t be any different. You don’t want to have kids only to end up being unable to give them much of a life. And you don’t want to jeopardize your home, retirement savings, and needs in order to have kids, either. Kids are great, but expensive. Piling on thousands of dollars in debt before the kid even arrives only adds to the financial difficulties.

Why Are Student Loans Acceptable?

June 17, 2008 By Cortni Marrazzo 23 Comments

I’m sure you have heard that there is a difference between “good debt” and “bad debt.” Bad debt is usually associated with credit cards, car loans, and other debts that aren’t secured by something that is growing in value. However, the term “good debt” is often given to such debt as mortgages and student loan debt. I can understand how a mortgage could be considered a less-risky type of debt in the fact that your house will (hopefully) rise in value while you are paying it off. Also, you can’t buy a percentage of a house at a time and pay as you go — you either pay cash or get a mortgage for a portion of it. I am continually perplexed however, that student loans are considered “good debt.”

There are many reasons people give for student loan debt being acceptable, however I personally think it is “bad debt.” I would consider any debt in which the payments are taking over your budget and keeping you in bondage, to be “bad debt.” Even if you have a mortgage, but the payments are higher than you can afford and are straining your budget, I would consider that “bad debt.” That thought aside, there are a few reasons why I would challenge the societal norm that says that student loans are a part of life and are an acceptable type of debt for most people to carry.

Student loans are not inevitable

I know that college prices are rising and that school is expensive — there is no denying that. Many people assume that students should attend college right out of high school and should take out student loans to do so if they can not afford it. This, however, is not the only option.

When purchasing any larger item, people always have a choice to go into debt for it, or wait and save up for the purchase. Education is no different. But the beauty of education is that you can go at your own pace. You don’t have to save up a large chunk of money to pay for 4 years of school at once. Students can work through college and pay for their schooling as they go in order to avoid student loan debt. It may take an extra year or two, but a few extra years aren’t going to hurt that much. Graduating two years later without any student loans will put you a lot further ahead than graduating with 10 years worth of student loans.

Our society doesn’t like to delay gratification and thus the student loans pile up in our nation. It seems that today’s mantra is “get an education” which equates to “get into debt” — a horrible message to send the youth of our nation into the world with. Student loan debt isn’t inevitable — there are ways to get aid and pay for schooling as you go through it. Unfortunately many students aren’t willing to do what it takes to pay for college as they go, or they simply don’t realize the huge financial benefit of doing so.

Student loan debt may not pay for itself

The premise behind borrowing so much money for your education is that you will end up with a job that pays more (and sooner) than if you don’t get a degree or wait a bit longer to get your degree. Unfortunately, this isn’t always the case. Many students decide on their major when they are 18 or 19 years old, when they really don’t know what they want to do with their lives. 4 years later many students have a degree in something they are no longer interested in and are stuck working in that field because they have to pay back their student loans. If many students were to wait to go to college until they knew for sure what they wanted to do in their career, their education money would go a lot further and they would be a lot happier.

Even if a student knows exactly what they want to major in, there is no guarantee that they will get a high paying job right out of college. If their desired career even happens to promise a high salary, students still have to work their way up in their career to begin making a decent amount of money. This often leaves educated students with degrees stuck making average salaries, but having to pay extremely large student loan payments in the early years of their financial lives. These students lose the power of compounding interest in their retirement accounts because their loan payments often make it impossible to even contribute to a retirement plan.

Student loan debt is simply that: debt

Even though student loans are used to pay for education, they are still debt. The bottom line is that it is still money borrowed to purchase something that you can’t afford at that moment. Whether or not it is an investment, if you have to take out a loan, it’s beyond what you can afford. Add to that the fact that many young people who take out student loans aren’t financially aware at that age and they don’t understand the repercussions of such a high amount of debt. This is why students will often take out more student loan debt to pay for lodging, food, books, and anything else they can get their student loans to pay for. This is also the reason why many loan/debt websites, such as loans-advisor.com, put strong emphasis in teaching students how to plan their repayment for the loans. When you are 19 and in college, the last thing on your mind is the fact that you actually have to pay these loans back. I honestly wish that more students understood the full reality of this truth.

It seems that today everyone is in such a hurry to get things done and over with, and this is especially the case with school. Who says that you have to complete a bachelor’s degree in 4 years? Why can’t it be 6? And why are so many students encouraged to have the “college experience?” I can guarantee that the fun of living on a college campus and finishing in only 4 years will not make up for a tremendous amount of debt in your adult life. I just wish I could see more people actually fund their own college tuition and not go into debt over it. I also wish that student loan debt wasn’t so “acceptable” and honestly that it wasn’t so easy to get. Whatever happened to go old fashioned “pay as you can afford it?”

(Image courtesy of a.mina)