I’m sure you’ve heard about good debt vs. bad debt. Supposedly, good debt is the kind that will produce some kind of profit in the future. Bad debt never produces a profit; it only takes a part of your income every month.
But here’s the thing. The idea that debt is “good” is usually based on a false assumption… the assumption that the debt will “always” pay for itself.
For instance, most would say that a mortgage is “good” debt. What is that claim based on? It is based on the false assumption that home values “always” go up.
Fact is, home values have gone up for as long as most of us remember. But a quick study of history informs us that home values often go down. Sometimes they go down a lot.
Already in the U.S. and England, there are rumblings of a massive real estate correction. If prices drop, will home owners still believe that a mortgage is good debt? Probably not. Many folks will have to bring money to closing just to get out. In other words, they’ll have to pay to sell their homes.
Others won’t bother. They’ll just go to foreclosure.
The problem with home prices is that they’ve been fueled by the “bigger fool” theory. People pay too much for homes because they believe there will always be a bigger fool to buy the home when it’s time to sell.
Guess what? There will come a day when the market runs out of bigger and bigger fools. Somebody will be caught holding the bag.
How about a college loan? Is that good debt?
I’d say it depends on your major. I have personally found that a degree has little bearing on income in the fields I worked in. In one job I earned over $10,000 more per year than a co-worker who had a Master’s degree. I don’t have any degree.
The same was true in another job. I out-earned many co-workers with college degrees.
Why was this?
I believe it’s because employers are inclined to pay on performance once you’re in a job. I also believe it was because the degrees (in many cases) were not directly related to the job.
If you are going into a field that requires knowledge of the sciences (like engineering or medicine), then you absolutely need a degree, and getting one should be viewed as an investment.
Just be careful before taking on student loans with the hope of getting a degree. You may never complete your degree, in which case the loans will still have to be paid. And your degree may not affect your earning power whatsoever.
What about debt to grow a business?
Sometimes it’s good. Using credit to invest in a business can pay off big time. But not always.
The problem comes when a person goes into debt to pay for get rich quick schemes. Really, this isn’t an investment at all; it’s a gamble. In any get rich quick scheme, a small percentage will make gobs of money. The rest will lose thousands.
Another way entrepreneurs overspend is on information. They subscribe to dozens of newsletters. They spend thousands on home study courses. But most of the time, the information is never put to use. So the money invested is a complete waste.
If you are going to go into debt for information, make sure you actually use it. Information without action is useless.
Ultimately, every kind of debt has a “dark side.” A select few forms of debt have a “bright side” in addition to the “dark side.” Just don’t get so blinded by the “bright side” that you fail to account for the risks.
Be especially careful if you think your debt is for something that “always” pays for itself. Because there are always exceptions. If you become an exception, you could be sunk by debt before you know it.