It may seem strange to think of debt in terms of good and bad. After all, isn´t it all just bad? Well, not exactly. Like so many other things in life, whether debt is good or bad depends a great on how it is used. While you can use almost any debt to your advantage, provided you are judicious about what you go into debt for, there are some debts that are considered better than others.
There is some debt that is considered "good." In fact, in some cases debt is even considered an essential part of effective asset management. The best example of good debt is a home mortgage. This is because a home represents an investment. Your home is likely to appreciate in value, ultimately allowing you to get more out of your house than you put in. On top of that, in many cases the interest that you pay on your mortgage is actually tax deductible. So there are definite advantages to getting into debt over a home. Here are a few other investments that can be considered good debt:
- Starting a business. The chance that you will make money, enabling to discharge your debt and build wealth is good, if you have a viable business plan. And most lenders won´t front you the capital unless you do.
- High return stocks or bonds. If you are likely to get a high return on certain stocks or bonds, taking on some debt so that you can make the investment might be a good idea. Be sure you understand the risks, however. You could lose it all if you are not careful.
- Education. Loans for a good higher education are considered an investment, as they lead to skills that allow you to land a better-paying job, allowing you to pay off your loans and take advantage of your earning potential. Plus, federal student loans have lower interest rates, so you are not paying as much to use the money.
When good debt goes bad
As is recommended for so many things, however, moderation is necessary. Good debt can get out of hand, especially if you use the fact that it is "good" as an excuse to borrow more than you can really afford to repay. One example is purchasing a home. Just because a mortgage is considered good debt, it does not mean that you should buy the biggest home the lender says you buy. Carefully consider what you can afford. Getting in for too much house can mean you lose it down the road.
The same rule is true of other investments. If you think that you can only pay back $2,000, don´t take out $3,500 so you can purchase more stock. Evaluate your financial situation, and make sure that you aren´t adding undue stress on your situation by borrowing a huge amount. Likewise, avoid going all out for education. Most people are not able to pay back an Ivy League education, and in many cases the earnings from an Ivy League degree aren´t that much better than one from another school-but you´ll pay a lot more for it.
The bottom line
Some amount of debt is necessary in our society. Few people can plunk down $130,000 for a home, much less pay for four to ten years of higher education schooling. How many of us really have $5,000 laying around that we can just toss into a stock that will give us a killer return at the end of a few years? Debt can help you build wealth, and it can be a sound decision. But it is one that should be carefully thought out.