Review: Good Debt, Bad Debt

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Each Friday, The Simple Dollar reviews a personal finance book of interest.

good debt bad debtI picked up this book to challenge my own thinking, nothing more, nothing less. Before I opened the cover to this book, I did not subscribe at all to the idea that there is “good debt” and “bad debt.” I believe that all debt is bad, and the wretchedness of the debt depends entirely on your interest rate. After all, all debt has to be repaid out of the pocket of your future self, right?

Jon Hanson takes the opposite perspective. Good Debt, Bad Debt centers around the idea that there are in fact some forms of debt that are actually good, because they move you (at a low cost) towards a big goal, like home ownership.

Does his argument have the necessary meat to convince me? Let’s find out.

One: The Debt EffectsThe Invisible Hand of Debt
Hanson does start off with the premise that debt is a negative, pointing out that debt is a pretty poor bargain with four nasty side effects: loss of freedom, loss of cash flow, loss of time, and loss of opportunities. He argues that the only acceptable debts are the ones that don’t have these negatives: loans to get an education (which increases cash flow over the long haul), start a business that you’re prepared to start (ditto), or a real estate loan (a mortgage, for example) that you’re properly leveraged in (which could theoretically increase your cash flow if we weren’t in a disastrous housing market). Basically, Hanson argues that all debt is bad except debt which leads directly to greater cash flow. I can at least understand that philosophy, even if I think the lines are fuzzy – for example, if you need a car to get to your job, wouldn’t that make a car loan good debt? Hanson’s not really clear on the delineations – I think they vary from situation to situation.

Two: Emotional HostageHow Do I Get Free from Me?
Here, Hanson makes another major point that I largely agree with. He states that we’re largely guided by emotion and that it takes self-discipline in order to not just be guided by whatever our heart wants. We have to be mindful and watchful of our choices, because without thinking about the choices carefully, we’re very prone to just following our inner emotions, which can be easily swayed. In other words, he urges people to trust their minds and not their hearts any time there’s money involved.

Three: Burn RateSpending, Not Income, Determines Wealth
Another astute point: “It is hard to see spending as a problem while all of your existing needs and many desires are being met.” I think that statement does a beautiful job of explaining why many people in America live paycheck to paycheck or, even worse, in a state of perpetual debt. Hanson eventually proposes that people focus on cutting their spending instead of a perpetual focus on increasing income, because, as he argues, income comes and goes but spending habits stay with you.

Four: Delayed GratificationDon’t Wait to Get It
Hanson basically argues in favor of applying “the six month rule” here. Whenever you’re tempted to buy something unnecessary, wait six months. If you still want it, buy it. The reason this works is that you’re often prone to completely forget about the item you want, and even if you do remember it, it’s likely that your interests and passions will have changed by then. Of course, this presents another problem: it requires you to separate yourself from immediacy and the type of purchases you *have* to make in order to put up a false appearance of wealth.

Five: I Don’t Know About My PastBuy My Future Is Spotless!
Hanson tells some of his life story here, and I found a lot there to identify with. He grew up as I did, in a household without much money that spent whatever they had as soon as they got it. Don’t let your past motivate you – the “I’ll show them” attitude, when manifested through purchases, is a very dangerous motivation, because it causes you to spend money on things you completely don’t need (or even want) in order to “show” someone who doesn’t really care one way or another.

Six: What If You Live?Make Work a Stage of Life – Not a Life Sentence
The “I’ll spend money now because you only live once!” excuse is extremely weak. If you do live, you set yourself up for many years of misery in order to have a few trinkets and flashy experiences now. The real problem with this excuse, according to Hanson, is that people fall into that trap because they view work as being a giant weight around their neck. In truth, work is just one little stage of life – not the whole thing. Work hard, succeed, sock the money away, and work will be truly behind you instead of just temporarily delayed by some escapism.

Seven: Real EstateBuy Five Houses – Get One Free!
This chapter is mostly a primer on real estate investing, a topic that doesn’t hold much interest for me at this stage in my life. Hanson’s advice is straightforward, however – buy properties that are in good shape and have value that will hold up over time and hold onto them until the time is right. In other words, Hanson advocates a “buy and hold” strategy for real estate – buy it if the price is right, then wait until someone wants to buy it for a price you want.

Eight: Driving Your Life AwayAre You Driving Your Retirement into the Ground?
The incessant need for a new car is a tremendous cost. Your best bet for maximizing your car’s value is by buying lower-end cars and driving them until they fall apart. The real key? Minimizing the cost for each month of driving. The average new car depreciates at a rate of $250 a month – that money, invested, can make a huge difference later on in your life.

Nine: Do I Have Records?My Pulse Began to Quicken
Keep track of your spending very carefully and then use that data to figure out what you’re actually spending money on. Not only will this information help you figure out where you’re spending more than you should, it can also help you determine areas where you can make cuts (like eating out all the time).

Ten: You Married Who?The Ultimate Good Debt – Maybe
The book winds down with some advice on marriage and family. His advice boils down to this: you find a good spouse by knowing them deeply as people before you get married – and that means talking about everything, including money. As for children, your best bet isn’t to talk to them about money. Children don’t learn much from talk – they learn from example. That means if you want your children to have some financial sense, it’s time for you to step up to the plate and show them how it’s done.

Some Thoughts On Good Debt, Bad Debt
Surprisingly, given the title, I agree with most of what Hanson has to say. The “good debt, bad debt” dichotomy wasn’t nearly as dramatic as the cover made it seem and it was really only discussed in the first and eighth chapters.

Good Debt, Bad Debt is not a good name for this book. The main theme of this book is actually that getting your spending under control is the key to wealth. I wonder if a lot of readers were surprised by this?

Was I guilty of making unnecessary purchases to “show” my friends and family? When I look back at the “heavy spending” stage in my life, I can’t help but wonder if I wasn’t spending at least a little bit to impress others. While I did watch them fanatically, I did enjoy showing my enormous DVD collection to others when they’d visit.

Is Good Debt, Bad Debt Worth Reading?
If you’re expecting an intensely helpful workbook to assist you in getting out of debt, this book’s probably not for you. On the other hand, if you want some realistic and well-written musings (with a lot of cultural and literary references) on debt and the modern financial lifestyle, this one’s quite a good read.

Good Debt, Bad Debt was one of those few personal finance books that was purely fun to read on its own, not because the topic was insightful or informative. Mostly, it just covered the basics of the premise “spend less than you earn,” but Hanson’s style made the book go down easy and quick.

If you want some enjoyable bedside reading on basic personal finance topics, Good Debt, Bad Debt definitely fits the bill. Just don’t expect it to answer every personal finance question you might have.

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20 thoughts on “Review: Good Debt, Bad Debt

  1. I love the idea of waiting six months before I buy something to see if I really need (or even want it). That’s definitely something I know I could do better.

  2. @Writer Dad
    I agree. It is amazing how much control our impulses have on over our spending. When we put them in check (by waiting 6 months, or even 2 weeks) our buying decisions often become a lot wiser.

  3. Waiting a while before making a major purchase has been one of the most successful tools my wife and I have used over the last few years as we were paying down over $97,000 worth of consumer debt.

    We were very close to purchasing a new car a few months ago and are now soooo glad that we waited a while to think it over.

    Car loans are definately not “Good” debt!

  4. I follow a pretty simple maxim concerning debt: “Only borrow money to make money.”

    Yes, this is a relative truth, and can be undone by poor discernment and a risky investing attitude, but those should be dealt with separately. I want my guiding principles to assume maturity and good judgment, and not coddle me too much.

  5. Oh, and a follow-up to my comment: my only current debt is the remaining 1/4th of my car loan (which will be paid off within three months, and will have taken less than half the term length), and my home loan (which we’re also paying off faster than scheduled). No credit card debt, no loans. Extremly freeing, psychologically and financially.

    I foresee no new debt in my future, but if I did take any on, it would be with a specific, definable, and low-risk goal in mind: borrowed capital for a business is all I could possibly foresee, and even that I’d rather avoid.

  6. An example of good debt:
    In “Get Smarter: Life and Business Lessons”, Seymour Shulich, a Canadian billionaire, illustrates how your money loses it’s value over time to inflation. I believe the rate was by half every 30 years.

    He says that if you can find a way to lock your money in a low interest debt over time you should, since the “guaranteed” rate of return would be the inverse of inflation. Any idea what that rate would be? If you can easily invest it at a higher rate, than I suppose this advice isn’t that useful.

    Does anyone else have any interpretations of Schulich’s advice?

  7. There are only two things you can really do with your income: spend it or save it. (Giving it away is really just spending it by proxy.) Anything you don’t spend is saved and anything you don’t save is spent.

    Steven Venti & David Wise, “Choice, Chance, and Wealth Dispersion at Retirement,” NBER Working Paper #7521 (Feb. 2000) studied the relationship between income and wealth for the National Bureau of Economic Research, using Social Security lifetime earnings and net income assessments for 3,992 households whose heads were near retirement age. They found that there’s a huge variation in wealth at every income level. Many low-income families have almost nothing, but the same is true of many high-income families. Some of the lowest-income households had managed to accumulate significant amounts of wealth. Being number crunchers, they identified several factors that explained wealth accumulation:
    * 5% of differences in levels of wealth accumulation were due to income differences.
    * 4% were due to luck/”chance events” like inheritances, medical bills, marital status, number of children.
    * 8% was due to investment choices.
    * The rest was due to how much the families saved, their lifetime savings rate.

    Those who accumulated large amounts of wealth were overwhelmingly the ones who made saving and investing a priority, regardless of their income level, individual circumstances or choice of investments. Those with high savings rates who ALSO had high incomes, good “luck” and wise investment decisions managed to supercharge their wealth accumulation, but the key was the sustained savings rate.

    …and the key to a sustained savings rate is managing spending.

  8. Trent, i’m relatively new to your website. What i’ve read so far i think is excellent. I really love the tone of your commentary and the information has been priceless. I’m learning so much that’s making an unbelieveable difference in my life. Anyway most of these books you review, 90% of the time contains information you’ve discussed in one form or another. Do you really feel that reading these books is neccessary or worthwhile or do you think that your website has all the financial advice and tools needed for someone to lift themselves from financial ruin.

    Thanks.

  9. “I believe that all debt is bad, and the wretchedness of the debt depends entirely on your interest rate. After all, all debt has to be repaid out of the pocket of your future self, right?”
    That is a really simplistic viewpoint. Student loans (sometimes) and homes (usually) are going to make you come out financially ahead than if you saved up and bought a home with cash or if you avoided college ot avoid the degree.

  10. I meant, of course, to avoid the debt.

    Though people have taken both those examples to the extreme and found was to have really bad home debt, and more commonly, a ton of bad student loan debt.

  11. StackingPennies, I agree. 8 years ago, we bought a townhouse for $104K(a home loan, of course). 5 years later, we sold it for $250K, after putting less than 10K of improvements into it. That was most definitely a good debt, in my opinion!

  12. I think that avoiding debt is critical, but also knowing when to take on debt may be even more important. One of my friends is in a family of rabidly devoted Ramsey fans- and they are wildly successful at it. Young families with 1 or 2 children, living on one income, with no debt other than their home loans- it’s great. Yet they flipped when baby sister (unmarried, no kids, no degree yet) wanted to take out about $3,000 in student loans- this would cover her ENTIRE associates degree- in a trade that she has known for years she wants to do. She’s getting gov’t loans which don’t acquire interest while in school, and over the next 2 years she’ll be saving about $100 a month or so. By the time she graduates, before the interest kicks in, she’ll have a degree and be able to pay it right off. And yet, the advice they gave her was to put off her education, save for a year (she’s only working part time, precisely to accomodate school) then go. The idea of putting off a $3,000 education for a year or more just to avoid the loan (when the education will triple her income) boggles my mind.

    Most people don’t use debt wisely, but that doesn’t mean that people who use debt aren’t wise!

  13. “Most people don’t use debt wisely, but that doesn’t mean that people who use debt aren’t wise!”

    I’ve never heard it stated quite so well. Nicely put.

    I am a big fan of the good debt/bad debt dichotomy. Currently, I’m paying on three mortgages – one for my home, one for my previous home (now rented and producing cashflow monthly) and one for a manufactured home (also rented and cashflowing). I consider this good debt because I am making a much higher rate of return each month than I would be in either stocks or CDs. Also, since the properties are rented for more than the expenses, my tenants are essentally paying off my mortgage. In return, I provide a nicely kept, safe house at a reasonable price, and if something breaks, all they do is call me instead of fretting about it. Once again, it is debt that is allowing me to increase my income.

  14. @Sophia: This is a highly-subjective matter, and I think the student loan was probably the right thing, but I do think math isn’t the only facet to consider. The personal growth she would experience by saving up for and buying something, rather than thinking “someone will pay it for me, and I can pay them back later!” would be *extremely* useful. In fact, I think spending a year learning that lesson — even if that means one less year earning income in her “real” field — would have been well worth the cost.

    Just my opinion, though. I’m going to encourage my own children to take the “wait and earn” route.

  15. Justin-
    I would agree that it is good to learn the lesson that you should save up for things, but I was more highlighting the irrationality with which people apply the “no debt at all costs” mentality.

    A bit more background- she saved up and bought her own car, and while she was living at home with her parents through high school she was expected to pay her own way. She has 0 debt of any kind, and lives in a one bedroom efficiency. Far, far too many people live off of student loans when they could be working. But, for those who have extensively researched their field, have chosen the lowest cost option, are working to offset as many costs as possible, have taken out the 0 interest loans while in school offered by the government, it’s hard for me to understand putting off an education that will substantially increase one’s income- especially when you are saving in advance to pay it off.

    Like you said, it is a highly-subjective matter and everyone has their own opinion on it. I just cringe when the “no debt” philosophy takes on rigid dogma and cannot accomodate natural deviations that are well thought out, and that is what she’s experiencing from her family (who also subsidized portions of their degree with student loans, before they were converted to Ramsey, haha :)

  16. @Sophia: Agreed, it does sound like she’s already disciplined enough and responsible enough for the minimal debt to be reasonable. Good luck to her, whatever route she takes!

  17. Currently, I’m paying on three mortgages – one for my home, one for my previous home (now rented and producing cashflow monthly) and one for a manufactured home (also rented and cashflowing).They found that there’s a huge variation in wealth at every income level. Many low-income families have almost nothing, but the same is true of many high-income families.
    _______________
    thomasjimmy

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