Last week I wrote about paying off your debt and I thought it would be worthwhile looking at debt in more detail.
This post is going to be all about the idea of good debt.
Is there such a thing as good debt?
“Good debt” is a term that gets thrown around a lot.
Let’s clear one thing up. It’s always better to not have debt than to have debt. However, sometimes debt can be unavoidable or a necessary step on your path to financial freedom.
Below I’m going to talk about a few different types of debt that are sometimes referred to as “good”.
There are two main ways in which you might take on a big beast of property-related debt.
The first is if you’re buying a home and getting a mortgage.
The second is if you’re buying a property as a form of investment.
The sad truth is that for most of us, buying a home requires borrowing some big bucks*.
Taking on debt in the form of a mortgage can make sense financially if you’re renting and could be paying much smaller monthly payments by buying a property.
It’s important to remember the “rent vs. mortgage” question isn’t as simple as which one equals a cheaper monthly payment. There are a lot of other costs and responsibilities that come with owning a home that are separate to the monthly mortgage payments (property tax, insurances, maintenance etc.).
Buying a home is not always a good investment either. Taking on a massive mortgage with the idea that you’re “guaranteed” to make money owning the property is naive.
Borrowing a large amount of money over a long period of time makes it manageable. It doesn’t make it “good” debt.
*Disclaimer - If you can afford to buy your home outright, please do!
Buying a property as an investment is a slightly different situation.
Often people think that buying their home by using a mortgage is a solid investment, it’s not. Buying a home using a mortgage can be a sensible life decision, but it is very rarely an investment.
Purchasing a property to either rent out or to fix-up and sell on, can be an investment.
Sometimes borrowing is required in order to be able to get the initial capital to finance an investment property, or to put money into a property to raise its value.
It’s worth keeping in mind that borrowing money to try and make money with property doesn’t always come up roses. By putting some cash up and borrowing the rest, you are taking on what’s known as a “leveraged” position. It was people being over-leveraged and lent out more money than they should have been that led to the financial crash of 2008. A lot can change in a short amount of time and you don’t want to get caught out with your pants down after borrowing a big chunk of money to invest in property.
If you’re dead set on investing in property, then taking on debt might be part of the process for you. However, there are other ways to invest in property that do not require borrowing. This can be through investing money into REIT’s (Real Estate Investment Trusts), or by buying your investment property with cash.
Not everyone can afford to buy property outright with cash, but not everyone should be investing in property. It can be a much wiser strategy to bide your time, save up, and start small rather than rolling the dice and taking on lots of debt.
Taking on debt for the purpose of investing in property can work well if you really know what you’re doing and understand the market. Even then, it’s impossible to predict what might happen in a year’s time, let alone 5,10,15, 20 years.
Taking on debt for the purpose of investing in property can turn out well, but it can also turn out terrible. Therefore, borrowing money for investing in property does not deserve the blanket statement of “good debt”.
Another topic that leaves many divided is whether or not student loans and student debt are a good or bad thing.
The argument for student debt being a “good” kind of debt are convincing.
Student loans provide people with the chance to invest in themselves. Many people can’t afford, at a young age, to pay their student fees outright. Which is understandable when you think about how much higher education can cost in the UK and the US. The goal of taking out these massive loans is that you’ll be able to increase your earning potential in the future.
Student finance borrowing and lending is sometimes structured differently to regular loans. In the UK for example, you only start paying back your student loan once you pass a certain earning threshold. How much you pay back each month is also tied directly to your earnings, so you’re only ever paying back a percentage relative to how much you earn. Student loans in the UK also have a relatively low level of interest and they do not affect your credit score or your ability to borrow money for things like mortgages.
All things considered, student loans can be extremely useful for many people. Now I don’t want to get political, but the system needs changing. You shouldn’t have to borrow way more money just because you come from a less privileged background. Big changes need to be made to higher education funding because soon a lot of people are going to be priced out of Universities simply because of the circumstances they grew up in, rather than their intellectual ability.
A student loan has sadly become a necessary evil, and most people who enrol in higher education will find themselves lumped with one. Again, it can be a good way to make sure you’re primed and ready to succeed in your chosen field but many of us (myself included) go to university and rack up big debt when maybe higher education shouldn’t be the path we take.
Unfortunately, student loans is big business and so everyone is fed the tale that you HAVE to go to university and as a result you HAVE to pay for it.
Credit card debt is another area sometimes dubbed as “good debt”.
Most people will agree that it’s never good to owe loads of money on a credit card.
The argument for credit cards being a good form of debt is based on a couple of things.
Firstly, having a credit card can be a good way to build up your credit score or rating. Having a good credit rating will actually make borrowing money cheaper for you when you have to. I’d argue that you shouldn’t aim to borrow money ever if possible. To be realistic however, I know that people have mortgages, car payments and phones on monthly contracts. Having a better credit score can allow you to get a better deal and pay less in all those situations.
It’s vital though that you pay off your credit card balance in full every month. This way you can build up a decent credit score without owing any money or paying loads of interest.
The other argument in favour of credit cards is that some will provide you benefits and discounts for spending on them. Again, this can be useful but you still need to make sure you’re paying off the balance in full. Getting bonus air miles isn’t a “good” excuse for racking up debt.
Credit cards can also provide you with extra protection and assurances for your purchases. I always prefer buying big ticket items or things like plane fares or holidays on my credit card, purely for the extra layer of protection.
Overall, having a credit card can be useful. Having credit card debt on the other hand, is not useful. Use a credit card like a weapon in your financial arsenal but do not fall under the illusion that owing money on there is “good debt”.
No such thing as good debt
My personal view is that there is no such thing as “good debt”.
There is “useful debt”, but not “good debt”.
Circumstances may mean that borrowing money is unavoidable but where it can be avoided, it should be.
You may get lucky and make some money by borrowing some money. But do not get lulled into a false sense of security and start believing that every time you borrow, you’ll win. It only takes one big lump of debt to potentially change the course of your life for the worse. So just make sure you take on debt with eyes open, a plan to pay it back, and a realistic mindset.
I hope this has cleared up a few myths about “good debt”!