Is There Such a Thing as Good Debt?

by Joe Plemon on January 13, 2010

Debt Protest - Nov 28, 2008
Creative Commons License photo credit: eric731

I confess at the outset that the phrase “good debt” sounds like an oxymoron to me.

Because I view “debt” with great negativity, attaching the word “good” to it doesn’t quite resonate. I also confess that I am not sure that I can be absolutely objective in answering the “good debt” issue because “good” and “debt” are subjective terms. Good to one person might not be so good to another. And debt is viewed as desirable by some and a plague by others. I therefore followed the council of Mrs. Jack (my fourth grade school teacher)…I looked these two words up in the dictionary. Here is what I learned:

Good: Being positive or desirable in nature; not bad or poor
Debt: Something owed, such as money, goods, or services

If there is such a thing, therefore, as good debt, it could be defined as “owing something, such as money, goods or services, in a way that is positive or desirable” or “owing something in a manner that is desirable”.

With that definition set, I need to make one more stipulation: we will only consider debt from the “before” perspective. Many will be quick to point out a time when their debt turned out all right (after the fact) but, simply knowing that it went all right that one time does not classify the debt as good debt. With that logic, borrowing money to play a roulette wheel would be considered good debt IF you win.

OK. We have some parameters set. Now let’s examine a few different types of debt to see how they meet our definition.

Borrowing money to finance anything that is quickly consumed.

This is one of the worst possible debts. Why? Because, be it a hamburger or a vacation, you have nothing to show for the money your borrowed. Getting billed for something you no longer own is just not smart.

I see nothing desirable with this type of debt, so I am ruling it out.

Borrowing for a car.

I consider car debt better than borrowing for a vacation, but still problematic. Why? Because a car is a rapidly depreciating asset. Even those who stay current on their payments are commonly “upside down”, meaning that despite all their monthly payments, they have negative equity. Many people who stay in car debt their entire lives struggle to save and therefore approach retirement with little net worth.

Is there a time when car debt is desirable? Hmmm. If one absolutely needs a car to get to a job, there may be a need to borrow to buy this car. This might be considered “allowable” debt, but I couldn’t label it as positive or desirable in nature.

Borrowing for college.

Money borrowed for an education is often considered an good investment. Why? Because the education will pay dividends by providing a good job. While this does hold true in many cases, I need to point out the downside of educational debt: the risk factor. What do I mean? Simply that there is no guarantee that this debt will provide a job that will allow the debt to be paid off. According to Career Consultant Dan Miller, 80% of college graduates, 10 years after graduation, are not working in their field of study. And many students, after accumulating huge hunks of student debt, never graduate. Guess what? They still owe the money. To compound the problem, jobs are scarce for this age group: based on a CNN study, unemployment rates for ages 20-24 is 50% higher than the general population

Now the question: Is a Student Loan good debt? Remember our “before” stipulation: while the loan MAY work out fine, no one knows when borrowing the money if he will graduate or nab that great job. Because of the risk already mentioned, I have trouble thinking of the debt as desirable. College loans therefore flunk the “good debt” test.

Borrowing to invest.

The practice of leveraging OPM (Other People’s Money) in order to make money has been around for a long time. This would include debt for “flipping homes”. Financial gurus have taught for years that leveraging is sophisticated and “good debt”.

But is it? Again, the risk factor needs to be considered. What happens when the market plunges? For real estate investors, what happens when the bottom falls out of the housing market? The borrowed money still needs to be paid back and, with depreciated assets, there may be little or no cash flow to make the debt payments.

Granted, many do well with leveraged money, but, once again, because of the risk involved, this practice cannot qualify as owing in a desirable way.

Borrowing for a home.

Because most of us will realistically never save enough to pay cash for a house, and because homes have historically risen in value, nearly everyone agrees that home mortgage debt is “good debt”. However, some home debts is better than others. Why? Again it is the risk factor. Ask any of the millions who have been foreclosed on in recent years. Obviously there is no guarantee that one or both wage earners will not lose their jobs and there is no guarantee that the home value will always appreciate. When income is lost and the house can’t be sold for enough to pay off the loan, foreclosures occur. Therefore borrowing for a house should involve a number of safeguards to lower the risk: no other debt, three to six months of expenses set aside for emergencies, a good down payment and a loan of not more than 25% of family take home pay.

So, with these safeguards in place, would I consider a home mortgage to be “good debt”? I would say …. drum roll please …. Yes. When risk is minimized, borrowing to buy a home is a positive and desirable thing.

Conclusion

The factor that rules out “good debt” in nearly every scenario is the factor that is all too often overlooked: risk. People like to think that if they qualify for a loan, they should borrow the money. Not so. Lenders will qualify you but they are not obligated to explain the “what ifs” of debt. It is always the responsibility of the borrower to keep both eyes open and assess the risk.

Based on our definition of “owing something in a way that is positive”, the only “good debt” I can think of is a home mortgage debt, and then only when proper safeguards are in place.

 

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{ 10 comments… read them below or add one }

Paul Williams January 13, 2010 at 10:16 am

I’d say your article is pretty spot on, Joe. The only part I would caution about is the section on student loan debt. The fact that 80% of graduates are not working in their field of study 10 years later doesn’t mean their education was useless. A college education is still a major asset in getting a job or promotion – regardless of your field of study. I don’t think it’s necessary for everyone to find success, but it does help most people.

However, going to the most expensive school, not trying to minimize your debt, or taking five or six years to graduate are all still mistakes to avoid. They’re just not smart, but they also increase the risks you face if you can’t find a job.

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joeplemon January 13, 2010 at 10:38 am

@ Paul,
Good point about the 80% of graduates not working in their field of study. I did not intend to imply that the education was useless; only that it is no guarantee for finding a dream job.
I have a college graduate son who NEVER worked in his field of study and now, eight years later, is doing well. I am sure he would agree that his education has been a positive factor .

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Paul Williams January 13, 2010 at 10:50 am

Right, Joe. And my point is just that when wisely used student loan debt could be good debt. The problem is that too many people don’t use it wisely – just like mortgage debt.

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JoeTaxpayer January 13, 2010 at 6:30 pm

Debt is such an emotionally charged issue. And while I have thoughts, I won’t have an answer. What if kids all took on internships so their college was paid for as they went? 6 years in school but a decent work schedule in a real job (no offense to the burger flippers, I flipped on weekends while in school).
A house. When homes are rising at a normal pace, matching inflation, it’s easy to feel that the price keeps getting ahead of your ability to afford it, and wanting to just get in. There’s certainly a risk of overextending, which is an issue. There’s a crossover where the cost of rent is higher than the monthly mortgage, and combined with the desire to own, will push people to buy.
I’d never even use the word ‘good’ to describe debt, I’d just look at the difference between debt one can afford and that one can’t.

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joeplemon January 13, 2010 at 6:49 pm

@Joe Taxpayer,
I went into the writing of this post knowing that there is no clear answer to my title question. My goal was to get others to ask the same question, so I appreciate your thoughts.

I actually had to write the post before I grudgingly conceded that house debt can, under ideal circumstances, be considered “desirable”. But my opening sentence still holds true: “good debt” still sounds like an oxymoron.

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Cedric D'Hue January 14, 2010 at 9:17 am

Hi Joe,

I am very encouraged to see articles dealing with this issue. Larry Burkett is generally acredited with basically saying there are no instances in the Bible where debt is viewed in a positive manner. I don’t have the exact quote but I’m fairly certain this is the general gist. Based on his insight on the Bible, I never characterize debt as good. Thoughts?

Thank you for bringing up these important issues and keep up the good work.

Cedric

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joeplemon January 14, 2010 at 12:00 pm

Cedric,
I am familiar with Larry Burkett and the statement that the Bible never says anything positive about debt, but I, like you, am not crystal clear on Larry’s exact quote. I have also heard Dave Ramsey say that in the Bible God never uses debt to accomplish His purposes. So…you make a great point: if it is true that the Bible never characterizes debt as good, who am I to do so?

I think you would guess from the tone of the post that I really struggle with ever calling any debt “good”. Good debt is still an oxymoron to me.

However, even if the Bible never says anything good about debt, I am not sure that the Bible explicitly condemns borrowing to buy a house, while using proper safeguards. I am certainly not looking for loopholes to justify debt, just clarity.

How about a new phrase: GREAT DEBT: Defined as former debt, now all paid off. With that definition, we could agree that there is such a thing as “great debt”.

Thanks for reading and for your encouraging words. Stop by often!

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SFaith January 22, 2010 at 3:47 pm

The Bible does not condemn debt, it just advises people to avoid it. It also admonishes those who have the means to lend to their brothers in need. I agree with you that the words good and debt just don’t quite go together.

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LE May 11, 2011 at 3:34 pm

I’m a Dave Ramsey follower, but Student Loan debt is where I differ with him a little. Yes, it would be great to graduate debt free, but I’d rather graduate quickly, with a small amount of debt than slowly(or not at all) with no debt.

If you can graduate in 4 yrs and get a good paying job, then a small amount of debt is OK. Versus, working for 6-7 years and going to school part-time. A lot of people quit/postpone school if it takes too long to graduate. Life happens.

For the same reasons Dave says attack debt smallest to largest, I say finish school quickly. If you’re stuck on it too long, you lose hope and quit.

The key is to be really frugal while in school and don’t take more than you absolutely need. I graduated with $21k in debt, but my income went up by $20k my first year out.

People that are graduating with $60k – $100k+ in debt are just insane (unless they are Medical doctors).

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joeplemon May 20, 2011 at 10:28 am

@LE,
Dave preaches a with broad strokes to a huge audience. Although I can’t speak for him, my guess is that he would have little problem with the way you handled your student loan debt. The ideal plan is to graduate with zero student loan debt, but personal finance being personal, sometimes one needs to weigh one’s choices. By the way, I like your analogy of paying smallest debt first to completing college quickly. I had never heard that one before.

@Sheila,
How true. People always USED to consider home ownership a very safe investment. However, after the real estate bubble burst, the best mindset is to think of owning a home as an expense instead of an investment. You are right: being debt free is the best way to go.

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