Even Good Debt Can Put You in a Bad Position

One of the debates that goes on in the personal finance world revolves around the concept of whether or not some debt can be good. It is true that some debt (like a home mortgage) is viewed more favorably on your credit report than other debt (like a car loan). But, in practice, you are still in debt. And, even though you may need to go into debt to afford certain large purchases, the fact of the matter is that even what is considered “good debt” can end up putting you in a bad position.


The Road to Debt Hell is Paved with Good Debt Intentions

We are taught that it is “acceptable” to go into debt for certain things. Homes and education are prominent on this list. However, when looking to purchase these items, we often focus more on the idea that this debt is “good”, rather than on how much we are actually borrowing. This is when we get into trouble:

  • Homes: We are told that our homes are good investments. We are primed to believe that mortgage debt is significantly different from other debt, and that it is no big deal — after all, it is secured by an appreciating asset. This mind set can be dangerous if you turn to creative financing methods to buy more house than you can strictly afford. The idea that having more debt for a bigger house doesn’t seem like a bad thing, because mortgage debt is “good.” But once the loan rates start re-setting, or if you run into financial difficulty, that “good debt” is suddenly something very bad hanging over your head.
  • Education: For years we have believed that student loans are the way to go. Schools come up with bloated estimates of how much you will “need” with tuition and living expenses and then encourage you to borrow the money. Because student loans are available, you might be willing to go to school for longer, or go to a more expensive school. After all, an education is an investment in your future, right? Unfortunately, many people do not make enough in their first job to adequately begin paying back their student loans. Some find themselves saddled with student loan debts exceeding $100,000, and have to try and make payments on it with salaries of around $30,000 a year.

Other items, such as a car to get you to work, or a small loan for investment purposes, seem like good ideas at the time, but once you get carried away, you realize that you are still in debt; it doesn’t matter how “good” that debt is if you can’t make the payments.

Knowing When Enough is Enough

The key to avoiding becoming buried by your “good debt” is to borrow only what you need. A bigger house might be nice, but do you really need that extra bedroom? A private university sounds like it might be great, but you can usually get a decent job with an education from a public university — for a fraction of the cost. A simple used car can get you to and from work reliably, with no need for an expensive new car. When most of us honestly evaluate our needs, we may find that we are inflating our needs to match what we think we “deserve.”

Before you take out that loan for a noble cause, consider your motivations, and think about what you can truly afford. Most experts agree that you should spend no more than 30% of your income on housing (I prefer to keep it to no more than 25%). You should also figure the affordability of your mortgage payment on what you will be required to pay when a teaser loan rates expires, or consider what happens with an ARM when interest rates go up. For education, you should get a realistic view of your likely salary when you finish and choose a school that will not end up being too expensive for your job.

Also, consider what you can do to reduce the amount of money you borrow. Saving up for a down payment, working part-time while in school and taking public transportation are all strategies that can be employed to reduce the amount that you need to borrow. Moderating your wishes to bring them in line with reality can also help.

In the end, even “good debt” is still debt. And you should do everything you can to borrow as little as you can get away with, and pay it off as quickly as possible.

Photo by alancleaver2000.

About the Author

By , on Apr 17, 2013
Miranda is a freelance writer and professional blogger, specializing in financial topics. She has written for a number of financial web sites, and her work has been linked to by many publications, online and off. Miranda's blog is Planting Money Seeds.

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  1. Damian says:

    All very good points. As a underwriter for a major bank in the US I would always see people with a lot of “good debt” that would turn into and lead to “bad debt”. It is a slippery slop that catches a lot of people. We as Americans need to stop relying on debt so much and start making sound financial decisions.

  2. Damien says:

    A lot of debt is pointless and bad. However debt is a very very useful tool. Consider a startup company that needs an expensive machine to make their products. They could wait until they slowly save via other means, losing 10 year of production. Or they could borrow, use the machine to pay back debt within 6 months and get an added 9.5 years of higher income. Debt can be good, but you must be extremely careful with it.

  3. Kelly says:

    Very good points. Looking back now I wish I found alternative ways to pay for school besides taking out so many different loans. Now that I understand these things that you mention from personal experience, I would have gone to a state school and worked while in school. Of course, hind sight is 20/20 but you’re right that I don’t make enough money to realistically cover the cost of my loans, I’m lucky my parents help out.

  4. I find it hard to believe that there is good debt. All debt is debt, and it is just an unnecessary burden in the long run. Living within or beneath your means to stay out of debt and in control of your finances is much more appealing than paying back bank loans for the rest of your life.

  5. I appreciate how you note that even though we may think of some debt as “good”, that it may not be when we go above our means. My younger sister is currently doing this against my parent’s warning. Instead of going to a small state school, she is attending a huge out of state University and paying 4 times as much for tuition. She expects when she gets out of school she will find a well paying job and be able to pay her loans back but unfortunately, she is not aware or knowledgable about the real world and the economy. It is a shame. My family tried to warn her but she refused to listen. We shall see how it turns out.

  6. I don’t believe in the concept of “good” debt, unless you are sophisticated investor in real estate. No debt is good and should be avoided at all cost.

  7. Bill says:

    Debt is a debt whether its good or bad, but it will depend with your financial position and how you pay it.

    What do you think Miranda?

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