Some people will tell you that any debt is bad debt. I’m here to tell you that those people are not only wrong, but they truly lack basic financial knowledge.
The picture/joke above confirms it! Good Debt really does exist! *To the blonde ladies out there, I’m glad you’re all so good at taking jokes.
Good Debt = Any debt where you pay a lower interest rate than you can earn in other investments
Don’t trust me? I’ll give you 30.2 billion reasons why I’m right.
$30.2 billion is the combined profit of Chase, Wells Fargo, and Citigroup banks during the first three quarters of 2010. Why does that matter? Because these banks made billions of dollars in profits by taking on hundreds of billions of dollars in Good Debt.
Most people are aware that a bank borrows money from its customers (deposits in checking and savings accounts, CD, etc.) and lends it out to customers for a higher rate of return than they paid to borrow the money (mortgages, auto loans, small business loans).
Instead of paying back the debt it owes, the bank uses the money it has on hand to invest it elsewhere and make billions of dollars. If the banks can do it, then why shouldn’t you?
If you have a loan at 2% APR (like a student loan), find an investment that gives you a 2.1% return or better. If you have a loan at 7% APR (like an auto loan), find an investment that gives you a 7.1% return or better.
Getting better than a 7% return is a risky bet, and you may not be comfortable trying to do that. I understand paying off loans at 7% before investing (although I probably wouldn’t). However, anyone who pays off a low interest loan with tax benefits on the interest (such as student loans) instead of investing is literally wasting money. You can get a guaranteed investment for 2-3%.
If you are talking to someone who claims “any debt is bad debt,” I recommend you ask them the following questions:
- Do you have a mortgage?
- Do you use credit cards?
- Have you ever borrowed money from someone?
If they answer yes to any of those questions, then they don’t even believe what they are saying. A mortgage is debt. Using a credit card is accumulating debt. Even if you pay off your credit card at the end of every month, you are still taking out a 0% loan for a few days before you pay it off. That, my friends, is debt. Even borrowing money from a friend or family member is debt (although it is almost always a 0% loan).
If you are someone who gets stressed when you know you owe money to someone, and you can’t sleep at night because you can’t help but think about paying off your debts, then you’re going to have a very hard time accepting Good Debt. However that doesn’t change the mathematical fact that Good Debt exists. If you choose to pay off good debt for your own peace of mind, just be aware that the income lost from not investing is real. You are paying real dollars for peace of mind.
If you are one of those people, and you are happy to pay for peace of mind, then I encourage you to do so. Just don’t go around telling people that all debt is bad debt, because it’s not.
There is plenty of good debt in the world. Don’t be afraid of it; embrace it! Use the concepts that make banks billions of dollars in profits to secure your own profits.
I have over $25k in liquid assets, and I still have over $20k in student loan debt. Why? Because it makes sense!
This article was the 4th ranked article out of 62 in the Best of Money Carnival at My Personal Finance Journey!!!
Kevin McKee is an entrepreneur, IT guru, and personal finance leader. In addition to his writing, Kevin is the head of IT at Buildingstars, Co-Founder of Padmission, and organizer of Laravel STL. He is also the creator of www.contributetoopensource.com. When he’s not working, Kevin enjoys podcasting about movies and spending time with his wife and four children.
Although I was completely stupud with my student loan debt ( using the excess to live the high life when I should have just gave it back) I don’t necessarily regret all of it. I wouldn’t have been able to pay for my education otherwise and thats something that no one can every take away from me.
There’s no shame in taking out student loans. Getting an education can be a great decision. And now that you have it, the goal is to be smart about your debt and to only pay it off if you can’t get a better return on another investment.
If you *know* how to turn a 2% loan into a 3% (or more) investment, then the debt is good.
Taking on a loan (HELOC?) just because it is low and spending it *and* paying interest is a bad debt in my books.
Of course it’s bad debt if you are taking out a loan and not investing any of your other money. That’s just debt that will accumulate forever. The key is to have debt and invest at the same time.
As long as you keep enough “liquid” to pay monthly installments on said debt if you suddenly find yourself without an income I’d say your idea would work.
Darla
My idea works every day. All you have to do is count the number of banks you drive by on your way to work. 🙂
Good debt does exist, I know this because I’ve personally benefitted from it.
At the beginning of 2010 I had approx. $6k in cash laying around and was contemplating what to do with it. My first instinct was to pay down the mortgage to save on interest (~$250 in 2010). Instead I put the money in the stock market and earned a return of nearly $4k.
I will choose $4,000 over $250 any day. In ‘Investing 101’ the concept of good debt is called leverage and although it increases your risk slightly, its a great way to maximize your returns.
Cautious note though. Good debt is only good if you CAN and DO find a return that is better. Most folks will simply spend this money instead of reinvesting, therefore for the general public the idea of good debt is similar to that of the diet Dr. Pepper man.
Perfect example. Not only did you get a better return on your money, but you also maximized your interest paid on your home loan, which is tax deductible.
I don’t believe any debt is good. Sorry.
Even with the credit card thing, the only reason why I use a CC is for the points. If I didn’t get points on ANY credit card, I’d just use cash or my debit card.
I also don’t believe in mortgages and lines of credit. Even student debt is one of those — is it really necessary? debts in my mind.
I went $60k into student debt and I’ll never do it again nor let my future kids do something like that unless they’ve REALLY thought it through
Saying all debt is bad and then using a credit card is very contradictory. Every credit card transaction you make puts you in debt until that card is paid in full (at which point you probably already have charges for the next statement. You’re perpetually in debt to the credit card company).
It looks like your definition of good debt is when someone gives you a 0% loan, and then pays you to take it (in this case, with credit card rewards). I agree that this is good debt, but it’s still debt.
I assume you get around 1% back on your credit card purchases. There is no fundamental difference between your credit card spending and taking out a 0% APR loan to pay for something you could have bought with cash, and then investing the extra money you didn’t spend in a 1% savings account. In both cases, you are paying no interest and making 1% extra money off the loan.
I’m one of the people that thinks that the only good debt is at 0% AND you already have the cash to pay it off.
I hate my mortgage and am trying to pay it off in a total of 10 years or less (we have 6 left and are on track). We do use credit cards for the cash back rewards, so that’s my only allowance to “good debt”. We pay them off every month (haven’t missed ever and I have had a credit card since I was 18…I just never put anything on it that I don’t already have the cash to buy), so it’s just 0% short-term loans.
I don’t care if banks and risk takers can leverage some debt into better profits – good for them! That’s just not how this girl rolls, lol. 🙂
Good for you knowing what you like. I have no problem with people who treat all debt as bad debt. It’s the people who try to tell others that they should get rid of all debt that I don’t like.
There are good kinds of debt and bad kinds of debt and you’ve done a nice job of outlining them Kevin.
It’s not so much as whether debt is good or bad, but how it’s used that’s good or bad. Student loan debt for the necessities is generally pretty good. Student loan debt spent on beer and Playstation games? Not so much.
Like any tool, debt isn’t inherently good or bad. It’s how we use it that counts. For someone like FB, she used it wrong in the past and vows to never use it again. For her, that’s learning her lesson. She’s not any more right or wrong in her opinion of debt than you are. She’s just be jilted by it.
So for someone like you (or me for that matter) debt is a tool we can be a little more aggressive with. For someone like FB, she just can’t handle having it.
Like a lot of things in personal finance, there are different “right” answers for different people.
I definitely agree. A loan at 0.1% is bad debt if you aren’t investing the money you’re saving in something better.
And yes, it can be different for different people. The point I’m trying to make is that just because certain people think all debt is bad, doesn’t make it true.
For my risk level, the only good debt are mortgages.
I wouldn’t borrow to invest though because I am not confident that I can beat the interest rate and there is a chance I will lose money.
You’re gonna have a tough time retiring at 40 if you don’t start taking some more risks! 😉
Great post! the definition you give for good debt is truly wonderful. I actually used my student loan to invest in my first real estate property. I love how the interest rate is low due to bad economy. It allowed me to invest in properties whereas I wouldn’t if the interest rate is high.
I love it! Congratulations, you’re the good debt winner! I love to hear stories like that.
Hey there! Very cool website! This is my first visit! Thanks for submitting this post to the Best of Money Carnival this week! Very interesting.
One thing though to keep in mind is to make sure to find investments whose after tax return still exceeds the good debt interest rates.
That is a great point. If you have realized capital gains outside of a tax deferred account, you will pay taxes (long term or short term depending on how long you hold). However, you never pay taxes on unrealized capital gains, so as long as you don’t sell, you don’t pay taxes.