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What is “Good Debt” And Should I Have Any?

That old adage “It takes money to make money” sums up the idea behind the phrase good debt.

That old adage “It takes money to make money” sums up the idea behind the phrase good debt. Taking out student loans to pay for a college education is a great example of good debt. So is getting a mortgage on a home or rental property or borrowing to fund a small business.

Loans for all of these have at least the potential to make money in the future as the business grows, you secure a higher salary because of a degree or the value of real estate appreciates. Of course, there is always risk even with good debt but the idea is that there is at least the chance for appreciation of the expenditure.

Students with large student debt realize the limitation of good debt despite the name because any debt may become difficult to pay. As those graduating in 2008 discovered, high paying jobs are not always available when you start looking for one. So, understand the risk involved.

Borrowing for a home is most likely the largest purchase a person will make in a lifetime, so it is critical to get it right. Take care to not buy house that is above your ability to comfortably pay. A home mortgage is one of the few ways the average person can leverage their money. Mortgages only require 20% down on the property and so in a strong housing market, the loan is worth the risk as long as the monthly payments can be made. The housing crisis left hundreds of thousands underwater on their homes and are still struggling to break even. Many mortgages especially subprime mortgages went into default so don’t forget the lessons of the recent past.

The opposite of good debt is bad debt. Debt used to finance DEPRECIATING assets such as cars and boats and goods bought with credit cards such as clothing have values that, for the most part, decline as soon as they are purchased. Credit cards that can’t be paid off every month are particularly damaging as interest on the debt accrues and compounds making that $100 sweater cost $150 or more.

An excess of any type of debt can be a burden that is difficult and maybe impossible to overcome. Always consider limiting debt whether good, or especially bad, when planning a budget. Your financial future depends on it.

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About the Author

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Lorraine Ell

CEO and Senior Financial Advisor

Lorraine is the CEO of Better Money Decisions (B$D) and co-author of the blog Better Financial Decisions. As a principal of B$D, she is excited to continue her long career as an investment professional which started when she worked in the 1980s as an advisor with Drexel, Burnham and Lambert and J.W. Charles and as co-owner of a Registered Investment Advisory firm.

Living and working in places as diverse as Jeddah, Saudi Arabia, and Budapest, Hungary has given her a unique perspective on the world of investing. Through these experiences she has learned that life can change in an instant and having a financial guide can make all the difference between a retirement fraught with worry and one with peace of mind.