Bad Debt vs Good DebtMany people have been taught that you cannot get ahead without bad debt. We are also inundated with advertising that tells us that we can have anything we want. All that we need to do is put it on our credit card. We have become an impatient society, we want it right now. We have lost the ethic of working for what we want. It is not how much money that you make; it is what you do with it. Consider two families that have identical incomes. Family A uses credit. They use credit cards, car loans and have a home mortgage. Family B pays cash for everything. Family B has a higher net income since family A has to pay interest while family B earns interest. Family A goes for instant gratification while family B earns everything that they own.
All debt is not created equal. We will classify them as good debt and bad debt. To simplify the classification we will say that good debt is a loan for something that you could sell at any time and repay the debt. This narrows down good debt to a home loan and possibly a home equity loan. A bad debt, of course, is a loan on anything that will lose value.
Let’s take a look at some bad debt. Home equity loans are in the gray area. They could be considered good debt if they are used to repair or improve your home, but you would be a lot better off to just save up the money for the project. Home equity loans become bad debt when used for purposes other than home improvement or maintenance. In other words a bad home equity loan is for anything that does not add to the value of your house. One other good use for a home equity loan is when the interest rates are low. You can use a home equity loan to refinance your mortgage. Home equity loans generally have lower costs than conventional home loans. I consider school loans bad debt. If you finish school, get a good high paying job and then attack the loan like mad, a school loan may work out. The problem is that there are too many things that can go wrong. At best even if you do graduate and get a good job there are always a lot of other expenses at this time in ones life. You are really behind financially when you start your working life in debt. Auto loans are bad loans that have become common practice to us. We pay interest on a vehicle that will only be worth one half of its original purchase price in five years. Lately it has also been common for us to borrow more than a vehicle is worth. We can trade a car in, that we still owe on, and roll that owed amount over into another vehicle. This gives us a loan amount that is higher than the value of the car that we drive away. We have lost our capacity to say NO. Finance companies are the kings of bad debt. You go to a finance company when you can’t qualify for a loan at your bank or credit union. If you don’t qualify for a loan at a bank or credit union you shouldn’t be getting a loan. Co-signing is a bad debt that usually involves family. Similar to a finance company loan, if someone can not qualify for a loan at a regular lending institution, they should not get a loan. The fact that they can not qualify for a loan elsewhere should tell you that they are a huge risk. Use this opportunity to teach them how they can get what they want by working harder for it and delaying the purchase.
If you want to get off of the debt treadmill, you must run as far away from debt as you can. You can not use debt to get out of debt. Even if you do, you have not changed your habits. You must change your lifestyle.
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