Good debt – is there such a thing in today’s economy, when people are losing their jobs and having trouble finding another?
Good debt is often thought of as an investment – financing for the future, if you will. Borrowing to finance a home, for instance, sounds like a worthy investment, since usually homes appreciate in value.
But can you really count on the real estate market to stay high? What if it should collapse?
The equity you have built up will collapse. Too, if you are purchasing that dream home, what else will you want to go along with it? Will you be purchasing drapes, new furniture, or a new lawn mower? Will you be remodeling? Will you get a new car to go along with the new house? Keep in mind that these things will not appreciate in value. They are a sunk cost, things whose value will deplete rapidly, but the debt will continue.
What about student loans? Isn’t this investing in your future?
You may get a better job, but it could be an entry-level job. About six months after you accept your degree, you will be expected to start making monthly payments on the loan. In today’s economy, jobs are not too certain. You may find yourself on the financial hardship list.
The purchase of a car could be considered good debt – not that the car will appreciate in value, but you will need transportation to get to work to pay off the debt. The car will have residual value also, if you need to sell it to pay off the debt. Buying a car that too high priced for your budget, however, could lead to your eventually defaulting on the loan.
Loans that might not be considered good debt include borrowing to buy nice clothes, for a hobby, a fancier lifestyle, a vacation, or short-term use items which you will consume, or which you will not be able to sell to repay the debt. Most credit card debt falls into this category. If you make credit card purchases, make sure you have enough to pay the card off each month. Otherwise, you will be stuck with a huge debt with no “collateral” to sell to pay off the debt.
In considering whether a loan might be a “good” debt, weigh the cost of the debt against your ability to repay the debt. While there is always hope for the future, you should be wary of borrowing money you are not certain you can pay back.
All debt must be paid back and represents a lien on your income. Debt also lowers your net worth by the amount you owe. You will always be “stuck with your debts” – keep that in mind when you decide whether or not to go into debt!