In a study by American Express, 53% of Americans cited reducing their debt as their top priority. That’s because, more often than not, we have heard the horror stories that racking up debt can bring. But not all debt is “bad debt”. Some could actually be good. But there’s a line between the two. Let’s dig into it.
Good debt is debt that has the ability to better our life in some way.
-education (More on this later)
-real estate (Personal home or investment)
-business
Bad debt is the debt taken on a depreciating asset for the only purpose of consumption.
-cars
-clothes, etc
There are three things from the list above that will bring on most debt for people and they are the following: student loans, mortgage, and car loans. So let’s dig into those a bit deeper and see the relationship between good and bad debt.
Student loan debt has two categories, private loans and federal loans. The average federal loan debt is $36k per borrower and the average private loan debt is $54k per borrower. In all, there are roughly 46 million people who have student loan debt for a whopping total of $1.7 trillion in debt.
We would think, at the high amounts that the average borrower has, and the total amount counted for, there is no way that student debt is good debt like it is categorized above. And I totally agree with that argument. And that argument also brings up an interesting discussion and point.
What it brings up is the fact that any sort of debt, even if it’s labeled as “good debt” can be bad when mismanaged.
Paying to get a higher education to further ourselves personally and professionally while taking some loans to do so is not a bad thing. If anything, paying to further ourselves in a meaningful way is good. However, when it is a systemic issue like we are seeing play out now, it gives us something that has turned into bad debt that at one point needs to be solved.
We can have this same conversation with mortgages. Whether it be for our own personal home or an investment. With the right mindset, strategy, and debt level, having real estate debt can be good debt. It is serving us a very important purpose and in turn we pay for it. There also come some great opportunities for those who have a good strategy and are able to leverage the real estate debt they have to create positive cash flows for themselves.
However, we saw in 2007 and 2008 what too much real estate debt with no strategy or plan looks like. That was also a systemic issue that took a major event to correct itself. This is another example of how something good, when mismanaged, can become a very big issue.
Finally, let’s speak quickly on car debt. This type of debt is nearly always bad because it is debt on a depreciating asset. No matter what is happening in the car market now, historically cars lose their value over time. So we’re taking out debt on something that is going to be worth less when we are done paying the debt. However, this debt is very necessary for a large portion of the population so it is very much a necessary evil. The main point here is staying within our means in the car we have. Trying to not take on too much debt with a high interest rate that isn’t affordable.
We can see the difference between good debt and bad debt and how at the end of the day it can become a fine line between the two.
Ultimately, instead of us looking at debt and immediately thinking that it is bad, let's take a step back and ask ourselves if it is furthering our life in some way. If yes, and we account for it within our cashflow as well as our goals, then it is good debt. If it is not furthering us in some way, and it is outside our cashflow or it is a hindrance to our lives, then it mostly falls into the bad debt category.
I’m soon recording a podcast where I’ll dive more into the specifics of this topic and break it down a bit further. Be sure to keep an eye out for that!