Good debt v bad debt
In working with clients, we’ve observed that some people have a “debt allergy.” They hate owing money to anybody or anything and pay off debt like student loans and mortgages at an accelerated pace. This attitude is prudent, and we wouldn’t try to talk you out of it if you just plain feel better being debt free.
However, if you’re open to considering using debt sometimes to advance your financial goals, it may be useful to identify two kinds of debt: “good debt” and “bad debt”.
First though, what is debt? Well, Wimpy from the Popeye comic strip taught us the basics. He offers to “pay you Tuesday for a hamburger today.” In other words, he wants to borrow 30 cents. (Thanks to the blog, restaurant-ingthroughhistory.com, for providing this basis for my guess of the cost of a hamburger in 1929, the year Popeye made his debut in print.)
Borrowing money allows us to buy/eat/use/experience something today and pay for it later. Especially if you don’t have enough money today to pay for the thing, that’s pretty darn useful.
- Good debt = an investment, buy something that will grow or provide a return, ideally more than the cost of the loan.
- A business
- Investment real estate
- Bad debt = discretionary purchases (i.e., Stuff you want, but don’t need*.)
- Could be that new tent, camera, bicycle, cell phone, etc.
- Maybe the Nordstrom annual sale.
- Okay debt = Gets you something you need, that you don’t have the cash for now. (Although we typically recommend saving up an emergency reserve for this purpose.)
- Replace an appliance that breaks. Fix the roof.
- A car when your old car breaks down.
- Pay the deductible on an insurance claim
* We’re only commenting on the prudence of taking on a loan (e.g., on your credit card) to pay for these things.
There are several other factors to consider when taking on debt, including your ability to handle the required payments, the terms of the loan, but perhaps considering the purpose of taking on the loan in the first place can provide some clarity on its prudence and your feelings about it.