No Such Thing As Good Debt?
August 23, 2007 by Pinyo.
Yesterday, I read “Good Debt?? There is No Such Thing” on Gather Little By Little. First, let me say that I consider Glblguy a friend and a very respectable blogger; but when I read the title I thought what the heck is he talking about? This prompted me to read the rest of what turned out to be his usual lengthy but excellent post. The six types of debt he covered were:
Credit Card Debt
Agreed, completely bad. I always pay them off each month. The finance charge and fees are just ridiculous.
Car Loans
Guilty as charged, I bought a new car and still carry a loan. However, I do not know if I can fully agree with Glblguy about buying a “used junker.” I travel long distances a lot and I would rather have the safety and comfort of a decent car even if it means I have to pay more. That said, I would agree if all my travels are only a few miles from home.
Oh, and I don’t know if I can ever bring myself to buy anything more than $25,000. I think that’s just a waste of money…but that BMW-7 is very nice.
Trip to Bora Bora
Agreed, if you have to take a loan to go on vacation, it is a bad idea…baddest.
Student Loans
Agreed to a degree. I think education is generally a good investment. It is certainly an option to “go to the local state school, work a part time job and pay for it yourself,” but that isn’t always feasible. Also, student loans are interest free for the length of your education, so you are really using other people money FREE for years. Moreover, you can use student loans interest as tax deduction. Overall, not a bad deal in my book.
I think student loan debt is good, as long as you can pay off your loans in the same amount of time you spent studying (e.g., 4 years to pay off student loan debt for 4-year degree).
Aside from the normal 15-year and 30-year fixed mortgages, I think other types of creative financing are really bad deal for the consumers. This is obvious with the current sub-prime lending meltdown and rampant foreclosures. I believe that if you need other type of mortgages — e.g. ARM, balloon, interest-only, etc. — you are buying too much house for your financial capability.
When you resort to these creative financing, you are basically sitting on a time bomb. Best case scenario, you will get by with very little cash to spare. Worst case scenario, you will go into debt, lose your house, and your FICO credit score will plummet.
Borrowing to Invest
Agreed, it is really difficult to make money buying stock on margin. I never invest on margin, but I have written check against margin to avoid liquidating my stocks.
Well, this is my take on the six types of debt Glblguy mentioned. What do you think? Is there no such thing as good debt?
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“over lengthy” ?
Yes, usually long, but good posts.
“I believe that if you need other type of mortgages — e.g. ARM, balloon, interest-only, etc. — you are buying too much house for your financial capability.”
I totally agree. I’ve been following the southern California real estate market crash/downward slide and all these people that got arm’s, balloon’s etc… are in a world of hurt right now. It’s very sad. Taking a risk with your home just isn’t a good thing to do.
Erin, thank you. And this is not entirely consumers fault either (although they should learn more to protect themselves), I have spoken to several real estate agents that are very persuasive in pushing these special financing packages to close the deal. One kept pushing even when I told him there is no way I can afford it.
In the UK the standard mortgage length is 25 years and no one gets a long term fixed rate. In fact, a long term fix is anything over 5 years. I’ve heard that its similar in Canada. Different markets call for different tactics.
Good debt is any debt that will pay off your loan and earn you extra money.
Let’s say you get a loan at 5% but you invest that money which returns you 7%. You are EARNING 2% on your debt.
Of course it’s challenging to find situations like this (and there is some risk involved) but they are out there. Businesses do this all the time.
Matt, thank you for that explanation. I wrote in my other post, “good debt gives you leverage.” I think it’s the same thing you are saying.
Matt Said:
Let’s say you get a loan at 5% but you invest that money which returns you 7%. You are EARNING 2% on your debt.
Of course it’s challenging to find situations like this (and there is some risk involved) but they are out there. Businesses do this all the time.
Risk, exactly. I think a better way to word this is, take a loan out at 5% and invest which SHOULD return you 7%. Oh, and hope that nothing happens to you that would keep you from being able to payback that money.
Too risky…I wonder what the % is of people that do this and succeed vs the one’s that don’t?
Pinyo, shouldn’t it be debt MAY give you leverage? The thing about borrowing money for investments is, you are guaranteed to have to pay the 5%, but you aren’t generally guaranteed the return percentage.
I guess maybe I am just blind, but I can’t see how owing anybody money could be considered a good thing…
glblguy - in an absolute sense, yes — good debt MAY give you leverage. There is inherent risk in everything, so good investment may give you positive return, good job may give you stable income, etc.
The reason I consider mortgage as a good debt is because the majority of us will NEVER EVER be able to own a house if mortgage does not exists. Do we have to pay for it? Yes, but at least it gives us a way to eventually own a house.
I think I have to agree with you here Pinyo. Some debt, like a mortgage, is acceptable debt. Not good necessarily, and not necessarily bad, but depending on your financial situation, it can be a tolerable thing. Where I live, it’s roughly the same cost to rent as it is to own. If I were to rent, I’d be paying someone else’s mortgage, and building them equity. To me, that doesn’t make sense. You also have to consider that you can write off the home interest and tax payments on the house on your federal income tax. The key is not to get in over your head and get an exotic loan to keep your initial payments low.
Eric, you made good points. I totally agree.
The problem is that everything in the western world is financed by debt, whether it be our own or somebody else’s. Personally I take the view that debt in itself isn’t a bad thing, it’s how the person taking on the debt responds. For example someone taking a debt which they know they will never be able to pay back or which they know which stretch them financially, is just being irresponsible and making it all the more expensive for those who manage debt better. If we say that all debt is bad then by default we have to say that the right to own our own home is wrong, the right to work is wrong and the right to have a pension when we retire is wrong. Let’s face it all of these things are based on debt, where it be ours or another organizations. Debt is just another feature of the world we live in (and always has been) but it’s the individual’s attitude to debt that causes the problem.