Knowing what good debt is, how to get into good debt, and how to manage various aspects of good debt will help you invest wisely, save money, and pay off your bad debt.
To achieve your financial goals, you need to get into good debt and avoid bad debt — which is what financial expert Charles Sizemore explains here.
“Debt is not inherently good or bad; it is simply a tool,” says Sizemore. “Used correctly, good debt is a great benefit to society and personal finance. Used incorrectly, it has the potential to reduce your financial well-being to smithereens.”
Sizemore describes how good debt helps you achieve your financial goals — and describes the difference between good and bad debt. If you want to learn more about getting into the right type of debt, read Good Debt, Bad Debt: Knowing the Difference Can Save Your Financial Life.
Does “Good Debt” Exist?
Some financial experts believe there is no such thing as “good” debt because they’re trained to be risk averse. One of the tenets of modern personal finance is that, all else equal, it is best to have as little risk as possible. And debt introduces risk and complexity into our lives.
All debt — even “good” debt — brings with it the possibility of financial problems. What happens, for example, if you lose your job and are unable to make your mortgage payment? For this reason, many advisors view all debt as bad. To be sure, “good” debt is only good if you understand the risks you are taking and are comfortable doing so.
Sizemore says, “It’s best to approach debt the way a business would — as the means to finance an investment — as not as the means to satisfy fleeting urges to shop!”
What is Good Debt?
Good debt is used to invest in the future; “bad” debt is used for current consumption. You have to be honest with yourself: Are you buying that new vehicle or laptop on credit for a legitimate money-making purpose — such as hauling equipment or professional writing — or are you buying it as a toy?
Education is a legitimate use of debt. A college education is often one of the best investments out there, given the increase in salary that a college graduate can expect. But, try to keep student loans as low as possible by keeping your living expenses modest. After all, you don’t want to spend the rest of your life paying your debt or college loans back!
A reasonable home mortgage loan can be a good use of debt, assuming that you do not borrow more than you need and that you keep your home payments tolerably low. When you lease an apartment, your rent generally rises every year with inflation. But when you own a home financed with a traditional fixed-rate mortgage, your payments do not change. Over time, this means that your house payments get smaller as a percentage of your income, which should rise with experience.
Again, this is only true if you use moderation when buying a home. Buying a new home that is too expensive for you is a burden and a liability, not a financial asset. Try to keep debt for other items, such as autos and appliances, as low as possible. I would consider these forms of debt “bad, but sometimes necessary.”
For more info about how good debt helps you achieve your financial goals, read 4 Types of Good Debt.
The Benefits of Good Debt
1. Good debt makes possible what might ordinarily be impossible. Without that initial loan or line of credit, many small start-up businesses would have never gotten off the ground. Without mortgage debt, millions of homeowners would still be renting. And without student loans, many professionals would never have had the opportunity to go to college.
2. Good debt often comes with certain tax benefits. Home mortgage interest and business loan interest are both tax deductible. It’s important, however, not to be penny wise and pound foolish. Never — EVER — take on new debts for the sole purpose of getting a tax break. This is a sure road to financial ruin!
Debt, used correctly and in moderation, can be a powerful tool that increases your long-term standard of living. But when used irresponsibly, debt can be your financial undoing.
Knowing the difference between good debt and bad debt can make the difference between retiring at age 50, or working until you’re forced to quit.
If you’re in a heap of bad debt, read 7 Ways to Get $10,000 – From Refinancing a Mortgage to Asking Mom.
If you have any thoughts on how good debt helps you achieve your financial goals, please comment below…
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Charles Lewis Sizemore, CFA, is the Chief Investment Officer of Sizemore Capital Management, LLC.