Personal Finance 101: Is Debt Bad?

Personal Finance 101Recently, I received a lengthy email from a reader who had a ton of basic personal finance questions contained within. I thought it might be interesting to start an irregular “personal finance 101″ series to answer and explain some of her questions.

Many people out there make broad statements like debt is bad in order to overly simplify their message. The truth is that not all debt is bad; there are many cases where debt can actually be a good thing.

Here are some examples of situations where debt is actually good:

Debt with no interest or a very low interest rate. Any time you can get debt with an interest rate below 4%, it’s a good deal. If nothing else, you can literally take that money, put it in a high-interest savings account, and turn a profit.

Debt that enables you to acquire an asset that won’t immediately start depreciating. This means that when you go into debt, you’re acquiring something that will hold its value. This usually means buying a home; even real estate isn’t in this category, as it can be quite volatile.

The reason people claim that debt is bad is because in the vast majority of situations, it is bad. Why? For starters, you are a huge risk. Think about it for a moment: how often does “something” come up and you “have” to spend more money? Ever had a life event occur unexpectedly and drain your funds? Ever wished you could change jobs – or even taken the leap and done it? These are all examples of risk that you introduce into the mix.

In short, the only debt that’s worthwhile is debt to own a home and debt which you can directly use to earn more. Otherwise, it simply isn’t worth the risk.

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8 thoughts on “Personal Finance 101: Is Debt Bad?

  1. Quang says:

    Trent, totally agree, a lot of people don’t like debt, but in actuallity the more debt you are able to handle the better off financially you are. Millionaire’s have Millions in debt. Donald Trump has Billions in debt. As long as your assets outweighs your debt, you are good-

  2. Jon Morrow says:

    A few other situations when debt is good:

    1) You’re trying to build credit. If you don’t have any credit, then you may have to take a high interest credit card or loan to build it. The same goes for rebuilding your credit. Just make sure you can pay it off anytime you like.

    2) You are buying an asset for less than it’s worth. If you run across someone that has to sell their house, and it’s worth 30% less than you can buy it for, then sometimes it’s a good idea to take on debt. Just make sure you budget more than enough for payments.

    3) The alternatives are worse. If you suddenly lose your job and don’t have any savings, then living off of your credit cards for a month or two is better than starving to death. Just make sure you have a plan for paying it off.

  3. mg says:

    I don’t think debt is necessarily bad. Massive 5 figure debt (not including the mortgage!) was the only way that my wife and I could purchase our first property – we managed that debt for one year until we were able to complete renovations, revalue and resell for a $120,000USD clear profit. We used that profit to finance the deposit and costs for our next property. We applied business logic: take a debt and use it with a calculated risk to make a profit. It worked for us.

  4. Jim Lippard says:

    “Debt with no interest or a very low interest rate. Any time you can get debt with an interest rate below 4%, it’s a good deal. If nothing else, you can literally take that money, put it in a high-interest savings account, and turn a profit.”

    Don’t forget about taxes when making the savings account suggestion.

    Inflation, on the other hand, will cut equally against the dollars saved and the debt itself–the dollars you pay back the debt with will be worth less than the dollars you took out in the original loan.

    I totally disagree with the comment that “the more debt you are able to handle, the better off financially you are. Millionaires have millions in debt.”

    The better off financially you are, the more debt you *can* safely and reasonably handle, but the reverse isn’t the case. And I doubt that most millionaires have millions in debt–rather, I suspect that a plurality if not a majority of net worth millionaires have net worths just over $1 million and assets just over $1 million, with very small amounts of debt. Look at the Forbes billionaire list–lots of billionaires are clustered in the $1-$2 billion range.

  5. plonkee says:

    Its definitely worth going into debt if the alternative is actual death. Although I suppose that could be considered money invested in earning more as dead people don’t get paid a lot.

  6. hustler says:

    I love debt…especially those 0% apr on balance transfer. I make thousands of dollars each year. For those 0% on purchases…i keep buying and only pay the minimum until the promo period is over. Love those debts.

  7. Jim Lippard says:

    To update my March 12, 2007 comment: In 2005, millionaire households (those with a net worth of $1 million or more excluding principal residence, of which there were 8.9 million such U.S. households) had average net worth of $2.2 million, of which $1.4 million was in liquid investments, and average debt of $165,000. See this reference.

  8. KC says:

    This doesn’t discuss student debt, which is nearly universal for college students. It is however, an investment in terms of jobs and earning potential, and certainly “good” debt.

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