Ignore anyone who tells you a loan is a good debt or bad debt. It’s like asking a Home Depot employee if a hammer is a good tool or a bad tool. It’s just a hammer. The real choice is whether it’s the right tool for the job.
1. Adding Emotions Leads to Poor Decisions
Calling certain types of debt “good” and “bad” creates an unnecessary link with emotions. Calling mortgages “good debt” conveys the idea that more is better. Choosing to get one or more mortgages because they are “good debt” makes the choice too simple. As we all saw with the financial crisis, signing up for a mortgage you can’t afford is a bad idea.
2. It’s Possible to Make Smart Decisions Using “Bad Debt”
Definitions of good and bad debt are like those on Bankrate.com. The site defines good debt as a loan that helps you create value, and bad debt is any loan that doesn’t create value. A business loan is considered good debt because you are building a business (value). A car loan is used to buy a vehicle that goes down in price (negative value). But there’s another way to look at it.
There are times when taking on “bad debt” might be a good choice. Let’s say you live in the city of San Francisco, your current salary is $60,000, and you don’t own a car. After some job interviews, you are offered a position right outside the city. The new salary is $70,000, but since there is no bus or train that gets you close, you would need to drive. In this case, getting a car loan would increase your income by $10,000 a year.
3. Tools Are Not Good or Bad
Debt is a tool for money just as a hammer is a tool for home repairs. If you need to install a ceiling fan, a hammer isn’t going to be worth much but a screwdriver will be. The hammer isn’t the right tool for the job, but it doesn’t make a hammer a bad tool. The true secret of using debt is knowing when it is the right tool for the right job.
Making Your Decision
When you are deciding to borrow money, there are two choices to keep in mind. The first is to decide if the money you are borrowing helps you make your life substantially better. A student loan can be a good idea if a college degree opens new doors and opportunities. On the flip side, getting a car loan for a BMW only strokes your ego. Traffic will be as bad tomorrow as it is today.
The second choice is if you are willing to take on the risk of all those monthly payments. When you borrow money, you owe a certain amount every month for years or decades. The payment is due whether you are on vacation or in the hospital. The extra burden can be a huge weight on your mind. If you are going to agree to those payments, you need to be willing to fight and survive the tough times.
On a side note, the world of finance and accounting does use “bad debt.” Investopedia says, “Bad debt is debt that is not collectible and therefore worthless to the creditor.” In other words, someone owes you money, and you’re assuming they won’t pay up.