Good vs Bad Debt

The myth of ‘good’ debt
Posted Jun 05 2009, 08:24 AM by Karen Datko Rating: Filed under: debt, The Dough Roller, mortgage, credit cards, debt reduction
This post comes from partner blog The Dough Roller.

You've probably heard of "good" debt and "bad" debt. Good debt is when we borrow to buy something that generally goes up in value, like a home. Bad debt is when we borrow for anything else, like a car, a boat, a meal, a dress, a cruise, a wedding and so on.

Many teach that good debt is fine, while bad debt is not. The theory goes that good debt makes us wealthy as the value of our purchased assets goes up, while bad debt makes us poor as we struggle to pay debts for which we have little to show. In fact, it's a philosophy I've followed my entire adult life.

And it's flawed.

Not all debt is created equal, to be sure. A debt backed by an appreciating asset is far better than debt used to fund a lifestyle we can't afford. Why? If for no other reason, we can always sell an asset to pay off good debt. With bad debt, all we have is the debt.

But the problem with good-debt versus bad-debt thinking is that it makes good debt seem more appealing than it really is. And there are two reasons for this.

First, debt, whether good or bad, takes away some level of our freedom. In my case, I'm 42 with enough good debt for two families. If I were debt-free, I could quit my day job and run this site full time. I'd really enjoy that, along with a few other business ventures I'd undertake. As it stands, my good debt is requiring me to keep my 9-to-5 job. Thus, good debt is preventing me from living the life I'd like to live.

Second, selling the assets that underlie good debt is not always practical. For most of us, good debt is our mortgage, and that's true for us. We have a mortgage and a home-equity line of credit used to renovate our home several years ago. We could sell our home, even in the current market, and pay off all of our good debt. We would have enough money left over to pay cash for a home in many areas of the country, but not where we currently live outside of Washington, D.C.

It's certainly a choice we could make. We would uproot our two high school children, sever all of our friendships, and leave many of our family members behind. We've chosen not to do that, and that's the right choice for us. But that just brings me back to all of our good debt.

Borrowing to buy a house is a perfectly rational decision. In our case, perhaps we purchased more home than we needed, although we do enjoy where we live. But the fact remains that good debt, at least for individuals, is a myth.

Instead of good debt and bad debt, maybe we should just think of it as debt and bad debt.

Related reading at The Dough Roller:

How to avoid a mutual fund's minimum investment

30 things I learned in my first 30 days of blogging

10 Web sites to look up the value of your home

Um....How it is a myth was not explained.
Bobby (Posted 06.05.09 10:15 AM ) Report Abuse

Maybe two equally valid classifications of debt could be: rational and irrational.

I agree that it makes sense to go into debt to buy a home (because 99% of us can't just pay in full) because you will eventually own that house and land and it beats shelling out rent that you'll never see again.

It makes sense to go into debt for a car, most of us need one to get to a job to buy the rest of our crap. But lets be reasonable about what we can afford. Maybe instead of an Escalade with rims you could put a down payment on a home.

It does not make sense however to spend money on a night out (or many other good, services and entertaining things) that may cost you fifty bucks on this one beautiful night that you'll end up paying two hundred for years and years down the road.

Rational and Irrational; Smart and Stupid.

Frank (Posted 06.05.09 10:29 AM ) Report Abuse

yep, the title is misleading.

good debt is borrowing to buy house wasn't the case this time, isn't it?

nate (Posted 06.05.09 10:44 AM ) Report Abuse

For those who follow the Good debt v bad debt philosophy- the writer's example of a home mortgage and equity line is actually bad debt. The home is not an asset if you can't sell it for whatever reason. Don't live in your assets, make them work for you.

Will (Posted 06.05.09 11:01 AM ) Report Abuse
No no no...U all are retarded...We own nothing, we are indebted to everything, so it is not whether to have good/bad debt debt/bad debt... You should have no debt. If you cannot buy your house with the cash you earned or earn than you have not earned it...There you go, earn/not earned is more like it. America has been raised to get things first and pay later and that is what has ruined our country. I propose that you start teaching your kids to stir away from debt all together and start thinking of ways to make positive changes for material equivalents. Ideas are the pools of dreams and if you have not noticed yet, making money is like breathing now a days, so anyone that says they cannot afford it is because they did not earn it :)
Corey Lambert (Posted 06.05.09 11:13 AM ) Report Abuse

Actually, I think the definitions of good and bad debt are wrong in this article. Bad debt is any debt we take on that we cannot afford. This does restrict one's choices or options because it negatively affect household cash flow and, thus, can negatively affect one's quality of life. Good debt should be defined as "using someone else's money instead of our own". When you buy something cash, you tie up your money into that item. What if you could borrow to buy that item, and instead, keep your money invested, even in a relatively low yielding money market account, and make more money investing this money than you pay interest on your borrowed money? You have "made" money while taking on debt. This is a good debt. Don't think it's possible? I offer this option every day to people who are looking to pay cash for a car.

car loan guy (Posted 06.05.09 11:21 AM ) Report Abuse

I have to say I was one of those who followed the rule of "good debt/bad debt" HOWEVER I feel differently now because in my opinion the rules changed.I think everyone has to look at their situation to figure out what they can do for instance house mortgage -if you loose your job and can't make the payment or sell the house and break even.Education use to be in my good debt category no longer it's debt you have to pay back and no guarentee of a job non the less if you get one that it pays decent.My point is the rules changed and we have to keep up.I am 55 ys old house paid for now for 5yrs, college educated no loans,drive cars for 12plus yrs,have 401K and 403b and intend to keep working.Oh yeah I am a nurse and for 30yrs always could get a job, actually have worked 3 jobs now down to 2 but I hear new grads do not have that luxury.My own personal money rule has been to keep as much of our dollars at home which meant the hubby and I worked opposite shifts-no child care costs,we shared vehicles drove them long and took care of all our stuff, did all our own work aka lawn,a simple but perfect life for us.It is all how you look at it.

Pam (Posted 06.05.09 12:38 PM ) Report Abuse

Jessica, never, ever convert unsecured debt and secured debt. If you can't pay your credit card debt you won't lose your house, but if you can't pay your mortage you will. So now instead of buckling down and paying off your cc debt in a year or two, you've just stretched your payments out over what 15, 30 years? Yeah, that's a good financial plan.

bad dog (Posted 06.05.09 3:20 PM ) Report Abuse

This post confuses me.

Point 1: The writer has enough home equity to pay cash for a house in most parts of the country. Sounds like good - make that great - debt to me!

Point 2: The Dough Roller chooses to stay in the DC area for reasons completely unrelated to finances (family and friends).

Conclusion: The mortgage is preventing the Dough Roller from "living the life I'd like to live".

Say what?????

I thought living in DC close to family and friends was the life the Dough Roller wanted to live. If this person is strapped on the mortgage, why not sell the house and rent in the same area? Could it possibly be that all that accumulated home equity is actually a GOOD thing? No sympathy for the Dough Roller here - he/she made the right financial moves and is just going to have to live with the consequences!