Is there good vs. bad debt?
Opinions vary. Some will disagree with mine, which is: there is “reasonable” debt and there is bad debt, but there is no such thing as “good” debt. By default, debt means we are “paying” for the use of someone else’s money and we are (for all intents and purposes) their slave until we repay that debt.
Want a 100% guaranteed return? Avoid paying (interest) for the use of money.
In my twenties, during the preparation of a budget, someone older than I once counseled me by saying: “You’ll always have a car payment.” While I had no basis to dispute that guidance then, I can now say: “No, No, No.” We can “choose” to have a car payment, but having a car payment is NOT a “requirement.” In fact, by having a car loan we are artificially (and quite significantly) inflating the cost of the car!
Let’s start with bad debt. I’d consider this to be the continued use of credit cards when we aren’t paying off the balance EVERY SINGLE month, especially for expenditures we receive virtually no long term value from. In the case of my (single) credit card, we’d end up paying an extra 13.24% per year on any outstanding balance. Let’s take a simple example. We “think” we need a new 55″ flatscreen TV (I mean, everyone has one). But, we don’t have the cash on hand to pay for it. It is presently on sale at Best Buy for $699.99. We add this purchase to an existing credit card balance. By doing so we will be paying an extra $92.68 for that TV in just the “first year” that we don’t pay off the credit card balance. We thought we got a deal / savings because the original price of the TV was actually $729.99. This just isn’t the case when we finance our purchases…
One principle to seriously consider is: If we cannot pay cash (or pay the credit card balance off at the end of the month) we simply cannot afford it.
Reasonable debt would be debt that is temporary and serves as an investment in our future. Examples include: a college loan, home mortgage or a loan to launch/expand a business. Why do I consider these “reasonable” vs. good debt? Because debt costs financially (hear that sucking sound?) and psychologically (if I don’t make that payment they can take my car, home, etc.).
This doesn’t mean we should never acquire debt (for reasonable purposes). And, if we do it makes good sense to eradicate debt as soon as reasonably possible.
Why? There are 2 approaches to achieving financial freedom: raise the bridge (increase income) and/or lower the water (decrease expenses). Debt service (interest) is an added cost on items previously purchased or experiences previously enjoyed. By reducing / eliminating that added expense we are more rapidly shortening the distance to our financial independence.
An article was published recently on Yahoo! Finance titled “The Wealthy Poor.” This outlines the downfall of spending everything we earn (and more). In summary, it is not how much we make (and spend) that defines financial freedom and independence. It is how much we keep!
“The definition of insanity is doing the same thing over and over again, expecting a different result.” ~ Albert Einstein
If you aren’t where you want to be financially and don’t have a clear path to getting there the book suggestion below can help.
In closing, I wish you the best in shortening the distance to your financial freedom.