I’m sure you’ve heard of the term “good debt” before. If you haven’t, let me give you a quick rundown. “Good debt” is used to describe an asset, such as a home or a college education, that can appreciate in value, or increase your value, and is (obviously) purchased using debt.
So it good debt a myth or is it truth? And if you do have good debt, why doesn’t it feel so good while you have it?
Investopedia describes good debt as debt that helps you generate income and increase your net worth. Sounds like a good reason to take on more debt, right?
“Good” debt generally has a lower interest rate than something that is considered “bad debt,” such as credit cards. But remember, you are still paying someone else to use their money.
So is there such a thing as good debt?
In a word. No.
Remember, being in debt to someone or some company is essentially the same as being a slave to them. Sure, if you can afford to have the debt, then it doesn’t really feel like you are enslaved since they leave you alone. But it can hinder many things for you.
(Interestingly enough, if you can afford to have the debt, you probably shouldn’t need to borrow anyway. But that’s a conversation for another time.)
In order to figure out why there really isn’t good debt, we’ll have to look at the two main types of debt that are considered good and normal for the average family or person.
Mortgages are quoted as the quintessential good debt. The reason for this is that mortgage loans usually have a low interest rate, real estate tends to appreciate over time, and there are tax benefits to having a mortgage. That’s all well and good, however, those benefits don’t automatically make a mortgage “good debt.”
Let’s look at each one individually.
Think about this. If you buy a $200,000 home with a 30 year fixed rate mortgage with $40,000 down (20%), even at a low interest rate of 3.5% you’re still going to pay $98,649.74 in interest. That’s almost 62% of your principal of $160,000 in interest! And that’s a low interest rate. If you’re credit isn’t that great, you are going to pay a higher interest rate, which means higher interest over the life of the loan.
Now, some of you may be saying, “Hey Tim, no worries there! I’m going to pay off my mortgage way earlier than 30 years!” I say “Awesome!” to that. BUT (and that’s a big but), what if you don’t?
Here is the danger in thinking a mortgage is good debt. If something is good, then that means it’s good to keep it around right? If I play a good video game, I’m going to want to play it again some day so I’m going to keep it, simply because it’s “good.” Good friends you want to stay friends with. Things that are good, we naturally, as humans, want to keep in our life.
The same goes with our mortgage.
Should we keep around the mortgage just because it’s considered good debt? The higher the mortgage period, the higher the amount of total interest you will pay.
One of the ways often quoted that a mortgage is good debt or a good investment is because of the appreciation of your home. It is going to go up in value! Who wouldn’t want that?!
To be clear, appreciation on your home is a great thing. However, the main reason why your home value is going up is because it is keeping up with inflation. That means, as the value of your home rises, the cost of goods all around you rises as well. Essentially, the value of your home is staying relatively stagnant, or only rising a little, because your money isn’t worth as much as it was before.
The US Census has data on new home selling prices from January of 1963 to today. The median was $299,000 at the end of 2015. At the start of 1963, the average new home selling price was only $17,200. Taking an average each increase in percentage of the years brings us to an average price increase per year of 5.66%.
(Data used in my calculation can also be found here)
For comparison the average inflation rate for the same time period was 4%. Not much of a difference!
So essentially, what you are gaining in home value is essentially lost to inflation and interest. That 1.66% appreciation over inflation is being eaten up by your 3.5% interest rate.
Perhaps, there is hope in the tax benefits?
Tax benefits are another oft-stated example of why a mortgage is a good debt. “Buy a house to lower your tax liability! What an advantage against the IRS!”
Unfortunately, that isn’t the case. Thanks to a handy-dandy calculator over at calcxml.com, it allows you to put in your mortgage information and figure out what your tax savings should be.
The way a mortgage works, the amount of your payment that goes toward interest goes down as the years go by, while the amount that is put toward your principal goes up. That means you pay the most interest your first year.
Using the same loan amount in our example mortgage above, that $160,000 loan at 3.5% will cost you $5,551 your first year. Your tax benefits, which will also go down as you pay less and less interest, would be $1,388.
So you’re shelling out $5,551 in interest to get $1,388 back in tax benefits. Not much of an investment if you ask me.
Mortgages should not be considered good debt.
Side note: I’ve also heard it quoted that mortgages can be used to buy a home specifically for renting it out. This makes you the landlord with all of the good and bad that brings with it. Scoring a renter that pays you more than the mortgage, you automatically make some profit. That money goes directly into your pocket.
On the flip side, when something breaks, you fix it and pay for it. If you can’t find someone to rent from you, you are stuck with two mortgages. Don’t get me wrong, this situation can definitely work to bring you some passive income, especially if you are working hard to paying off the mortgage on your rental property early. However, don’t count on it being easy for a while.
Student loans are considered good debt because it is considered an investment in yourself. Having a degree raises your intrinsic value to your employer or potential employer. Continuing your education and receiving a Masters degree, MBA, CPA, etc., further raises your intrinsic value and allows you to potentially get paid more.
Pay close attention to that word “potentially.” The problem with that is there is always going to be someone else determining your worth. You could have your Master’s Degree but making less than someone who only has a Bachelor’s Degree simply because you are working for a different company. There will always be a danger in someone determining that you are not worth what the market says you are worth.
Don’t get me wrong, I think going to school and continued learning is extremely important, but there are ways to do it without going into debt.
Have you thought about going to a cheaper school? There are many degrees out there where the employer doesn’t care where you got it from.
As an example, for certain certificates such as an MBA or CPA, it doesn’t matter what school you get it from. If you pass the CPA test, the only thing that matters to most employers will be that you are a CPA, not that you took all of your classes at a community college to save money.
There are people who go to school for incredibly specialized degrees that are making less than managers in the restaurant industry that never received more than their high school diploma. The difference is that the restaurant manager doesn’t have student loan debt amount that’s the equivalent of a small mortgage.
Now, I’m definitely not saying to quit your job and work in the restaurant industry. That job isn’t for everyone (believe me, I know.) The best thing to do though is weigh all of your options and think longterm to try and determine what your degree is going to get you and if it’s going to be worth the extra money. You may be able to go to community college for a couple of years or all four years. This will save you a significant amount of cash.
Work While You Learn
There is also the possibility of working a part time job, or even a full time job, in order to help pay for college. There are several people I work with that have done this.
In short, it isn’t necessary to take out student loans in order to go to college and earn a degree. However, because it’s wildly excepted and “normal” to take on a bunch of debt to go to school, it is encouraged by a lot of people, especially the lenders making money off of you.
Student loan debt should not be considered good debt.
Side note: While not impossible, student loans are difficult to get rid of if you were ever in the need of filing bankruptcy. They aren’t simply discharged like a lot of other debt. There are some steps you have to go through to prove that it will have undue hardship on you and those who count on you to support them (dependents). Yet, another reason to try and not take on any student loan debt.
Of course, this shouldn’t be construed as legal advice on the matter of bankruptcy and student loans.
So are these considered bad debt?
If they aren’t good debt like is widely thought, then that means they must be bad debt, right? In my opinion, not necessarily, but that goes more for the mortgage than student loans.
Instead of grouping my debt into good and bad categories, I like to use the terms necessary debt and unnecessary debt.
With all of the research I’ve done on debt, and the experience I’ve had holding debt, I can only think of one debt that is necessary.
That debt is a mortgage.
Because of the general cost of a home, it is almost impossible to buy one outright even with an upper middle class income. Think about it. Even making $100,000 a year, it would still take you two years to save up for a $200,000 home. And that’s without any other expenses, including food!
The stuff that is unnecessary debt would be credit cards, car loans, etc. I would even put student loan debt under the unnecessary category because there is definitely a way around it.
So is there such a thing as good debt? I’m sticking with no on that one.
However, I don’t like the term bad debt either. Bad debt implies that there is a big mark on you if you have credit card debt, car loan, or personal loan. That doesn’t jive with me.
The absolute only debt that I consider bad debt are payday loans. Companies that offer payday loans are in business for one reason and one reason only. They are trying to make a lot of money off of your misfortune. If nothing else, please stay away from those.
Otherwise there is only necessary and unnecessary debt.
There is no good debt.
What do you think? Do you consider some debt to be good and others bad?
What do you consider to be good debt, and why?
Let’s start a conversation!
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