December 16, 2013
Good Debt: Is There Such A Thing?
Debt is powerful. In our culture it is a fact of life and part of anyone's satisfying retirement. A recent study in the Wall Street Journal shows that 32% of all households with someone 65-74 years old are carrying credit card debt, while 41% have a housing debt. In fact, the median value of that mortgage debt is $70,000 based on the latest figures available.
We are familiar with bad debt: that is debt that drains our resources and puts a stable financial situation at risk. Examples? Credit card debt that rolls over month-to-month. Some of the most expensive debt one can accumulate, using these cards as open lines of credit have landed many people in serious hot water. The latest figures show an average household credit card debt of over $15,000.
Taking out a mortgage that is too big for you to comfortably handle, or using your home's equity to pay for things like vacations, new cars, or a room full of furniture can put the place you live at risk. We have just experienced a serious retrenchment of housing prices and stories of way too many folks upside down in their mortgage situation or foreclosed on when a job was lost and the monthly payment could not be made.
Bad debt is easy to understand.
So, is there ever such a thing as good debt? Yes, I think there is. Consider these situations:
1) Buying a house. Based on what I just wrote above, how can this be? If equity buildup isn't treated like a piggy bank, one plans on staying in a home for several years, and it provides a safe and pleasant environment, then mortgage is good debt if the monthly payments won't stretch the budget too far. This may be less of a dream today than it once was, but owning one's own home remains the goal of many.
2) Financing post high school education. Student loan debt averages over $31,000. But, it has become clear that a solid education is a requirement for any decent chance of success in today's world. Importantly that can mean college or a technical school in a brick and mortar environment or on-line. What has to be carefully considered is whether the dream of an Ivy League school is viable and even necessary. For most young people (and their parents), a state university, community college, or well-respected technical school will accomplish the goal of becoming a valuable employee for someone. As long as the level of student debt isn't too far out of line with the expected return on the educational investment, debt for some form of advanced education is good debt.
For retirees who find they either must, or want to go back to school to complete an unfinished degree, learn a new skill, or train for a new job, student debt can be good.
3) Covering unexpected medical costs. Even a few days in a hospital for an emergency or simple operation can cost tens of thousands of dollars. What insurance doesn't cover, you must. Borrowing money to pay to help yourself or someone you love in such a situation is a type of debt most of us would take on in a heartbeat (pun intended). Human life trumps debt. This is good debt only because it considers a human life to be priceless.
In these instances borrowed money is used to pay for something that is likely to appreciate in value over time or increase your income. Bad debt often is used to purchase something that does depreciate or have no value once it is over, like a one time trip to Bora Bora or 90 inch TV. Vacations and a new TV are not bad, in fact a trip to the South Pacific sounds pretty good. But, it is not a good idea to borrow money to pay for it.
Bad debt or good debt? A debt is really neutral. It is how you use it, what risks you take to acquire and maintain it, and what your ultimate plans for that debt are.