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.
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:
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.
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.
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