Jun 282009
 

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…

Charles Lewis Sizemore, CFA, is the Chief Investment Officer of Sizemore Capital Management, LLC.

  8 Responses to “How Good Debt Helps You Achieve Your Financial Goals”

  1. Miss Q,

    What an interesting lifestyle, to live in a camper trailer! I think it’s a brilliant way to save money and pay off your debt — because you’re right: rents (and household bills) can be incredibly expensive.

    And, a friend of mine recently bought a camper trailer from the early 80s. She loves it, and it’s in fantastic working condition.

    That’s a good example of a “good debt”: investing in something that gives you value and saves you money, which you can later sell. And, if you stay in one place and work close to where you live, you don’t have to worry as much about the price of gas.

    So yes, I agree that the camper is probably better than renting while you pay off your other debts…and I hope you keep me posted on how it’s going!

    Laurie

  2. Laurie:
    RE: Debt. We are traveling for husbands work and cant afford a home just yet, we have some debt to pay and back taxes…we are looking at a very reasonably priced Airstream Camper Trailer to live in. Since we have to find overpriced Apartments every time we move and both cities of which we live have high Rents ~ is this bad move? We like Airstreams because of the resell Value is very good. 82% of all Airstreams are still in use from the 70’s/80’s. So if we only do it for 2-3 years, I think this is better than renting while we pay off our other debts yes?
    What do you think?

  3. I’m glad this article helped you see the difference between good and bad debt, Tracy!

    I find it fascinating that some financial experts don’t agree that some debt is good. Suze Orman is one financial expert who does believe in good debt — but she still encourages people to pay it off as soon as possible.

    Good debt is an invesment in your future. It can actually be a repeated investment (eg, buying a house, renovating it, paying it off, buying a more expensive house, updating it, paying it off, etc). This may not be the best economy to be selling houses…but it’s a good time to buy…and get yourself into some good debt.

    By the way, this is not financial advice…it’s just me thinking out loud…

    Laurie

  4. This is reassuring :) thank you! Wow, to think that there is a difference. I thought there is one definite view on debt. This helps!

  5. Good job on pointing out that debt is simply debt. weither you think its good or bad, you still have to pay it off.

  6. Rick, very good points. Job security is certainly a factor in a person’s risk tolerance. And you are right about mortgage interest not being tax deductible in Canada. Canada in general is more risk averse than the U.S., and Canadians tend to carry a lot less debt. And the tax laws in Canada tend to reinforce this natural conservatism. Over time, this should mean a more stable financial system for the country.

  7. Thanks for this tip about mortgage interest — I live in Canada, and would LOVE to deduct our mortgage from our taxes! Lucky Americans.

    And, yes, I agree that assuming good debt is easier if you’re financially stable. But, the younger you are….the more financial risk you can take…and the more it can pay off!

  8. Your job security would play into this as well. If I know my job is safe or I am employable I can assume a bit more debt. Housing costs ebb and flow but good areas will at least hold their value and bubbles aside, appreciate. Incidentally, mortgage interest is only tax deductible in the US not Canada.

 Leave a Reply

(required)

(required)