I’m often asked if a particular kind of debt is a good debt or a bad debt. That question is usually followed up by questions like, “Should I pay off my debt or invest?”
Anyone in debt at one time or another has faced this same dilemma, but the answer is a difficult one because there are a number of factors in play, including a number of very personal factors.
- What are you overall financial goals?
- How MUCH of this particular debt to you have?
- How long will it take to pay off this “bad” debt?
- Are there emotional strings tied to the debt that are causing problems elsewhere?
Obviously, personal opinions on what is debt (good or bad) vary considerably, too. I personally consider student loan debt a relatively bad debt, but not nearly as bad as IRS debt or debt to payday lenders.
Others consider student loan debt an investment in their future earnings, which I also tend to agree with (to a point), which is why I’d rank student loan debt somewhere in the middle.
I’m sorry to say, I experienced nearly every kind of debt prior to my financial turnaround, so I had plenty of opportunity to develop my own personal debt ranking system. Feel free to use it to motivate you towards putting together your own get out of debt plan.
IRS debt. Of all the “uglies” to owe money, I can’t imagine any being more ugly than the IRS. They can garnish wages without a court order, and outright ignoring them can result in jail time. Not to be messed with.
Car title/payday loans. In my town, I’ve noticed that as the economy has worsened, more cars are in the sign-your-financial-life-away-for-$200-at-300%-interest establishment parking lots. Sad.
Personal loans with baggage. By baggage I mean loans attached to bad relationships, such as owing money on a car you shared with an ex-spouse, or a personal loan financed by your father-in-law, who like to remind you how much you owe him every time you see him.
Credit cards. Credit cards, as a tool, can be quite useful. However, credit card debt is vile. When I was deep in debt, I felt like I was working for the bank. My paycheck came in, and just as quickly as it arrived, it disappeared in minimum payments which barely cut into the balances after interest charges accumulated. It kept me awake at night, caused anxiety throughout the day, and limited my opportunities. Bottom line – being in debt sucks.
Upside down car loans. Car loans are not necessarily evil, unless you have no money to put down, buy new and drive off the lot owing more than the car is worth. Getting out of an upside car loan is not easy, so if you do finance a car purchase, consider gently used and using a trade and/or down payment to preserve some equity in the deal.
Enormous student loans. I emphasized “enormous” here because borrowing some money to finish off a degree often yields a nice return, considering college graduates usually earn more over the course of a lifetime. However, I don’t think that is an excuse to rack up over $100,000 in student load debt for a degree program in a field with starting salaries around $45,000.
Business debt. I’ve started and failed at a number of entrepreneurial efforts over the years. Fortunately, the one smart thing I did was not borrow a lot of money to finance these start-ups, so their failure didn’t haunt me for years to come. I recognize that many businesses need to borrow start-up capital to fund operations until revenues are flowing, but doing so puts the business (and employees) at enormous risk.
The (Slightly) Good
Mortgages. In a perfect world, people would be able to save up enough money to buy a home with cash. While that is certainly do-able, it isn’t practical for most of us. So, I concede that a reasonable amount of mortgage debt is not bad (and certainly not ugly).
However, as with student loan debt, the emphasis should be on reasonable. If your mortgage represents more then half your monthly income just because some “creative lender” allowed it, your home will not feel like a blessing. And you think getting out of an upside down car is tough, try an underwater mortgage.
When answering the question, “What is bad debt?” consider whether or not the money borrowed is for something that will appreciate over time. This may or may not be the case with real estate, making mortgage debt an acceptable debt in most cases.
Similarly, student loan debt is a somewhat acceptable form of debt (again, in small doses) as it often leads to higher earnings in the future.
Using that same logic, it’s easy to see why charging groceries to a credit card and not paying them off is bad debt. Three months later, the groceries are gone, but the debt is still around, accumulating interest and causing indigestion.
This post was included in the Festival of Frugality – Spend It Edition