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 go 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 its 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 quite 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 we we currently live outside of Washington, D.C.
It’s certainly a choice we could make. We would uproot are 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 rationale 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.Topics: Money Management