Is There Such a Thing as GOOD Debt in Business?
Aug 19
Written By Melissa Houston
Bad debt, good debt… you may have heard these sayings before. But what are they?
Bad debt is any debt that you’ve accumulated that holds little to no value. An excellent example of bad debt would be any item you put on your credit card. Whether it be for food, clothing, household items – essentially anything that you cannot pay for immediately and you have put on your credit card is debt.
Other examples of bad debt is financing a car. You might be surprised to hear that, but I’ll tell you why it’s bad. Because cars depreciate. They lose their value quickly over time. And now they have financing terms extended to 7 years? That is a lose/lose situation. The rule of thumb is to never finance your car over a period of 3 years. If you can’t afford the payments within a 3 year period, that means you can’t afford the car. Don’t extend the term of the financing period to make your car affordable. Why? Because the car’s value depreciates quickly and will not hold its value. So if for example, you lost your job and could no longer afford your car payments and needed to sell your car, if you chose a longer financing term chances are the balance owing on the car would be greater than the car’s value.
Bad debt also has higher interest rates on their loans. Examples of that are definitely pay day loans (never do those!!!), lines of credit, and personal loans.
Now on the contrary, some would argue the benefits of good debt. So what is good debt? Good debt is when you are buying something that is considered an investment in your future and need it financed.
Common examples of good debt are mortgages, student loans, and business loans. The idea behind that is these are the type of loans that are designed to get you ahead in life. A mortgage offers you a place to live that you are paying into vs the common myth that renting is just throwing your money away (a blog post for another day). So when you have paid off your mortgage, despite the THOUSANDS of dollars paid in interest, you own the house in the end. And the house theoretically is to appreciate over time.
Student loans and business loans are also considered good debt because you are investing in your future – increase your income therefore increasing the return on investment.
So is there really such a thing as good debt? Some argue yes, some argue no.
My answer is it depends. Let me explain.
If you buy a house that you can’t really afford, and you are pretty much indebted to that mortgage for 30-40 years, is that really good debt? The alternative would be to buy a house you can afford, pay that house off in 15-20 years, pay less in interest expense, then live happily ever after. I like the latter a lot more.
In that example, I would consider the house you can’t afford to be bad debt and the house you can afford to be good debt.
Other examples are student loans and business loans. Ideally I would argue to save up and pay for as much as these costs upfront, but use the debt to cover what you NEED.
For example, when my husband went off to post-secondary school, he saved nothing for the experience and relied on all his student loans to get him through. He chose a major he hated and graduated with $40,000 worth of debt. Not long after, he returned to trades school and became an electrician with zero debt from trades school. The $40,000 on student loans was extremely bad debt.
So the purpose of this blog is to present to you how “good” debt may be ok, but it all depends on your approach to it. If you aren’t serious about getting ahead and using the debt as a means to get ahead, then I would discourage the use of it.
I understand that sometimes debt is unavoidable, and I’m not against debt – I choose to be wise about it. My bottom line is only go into debt making an informed, smart decision.
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