“Good debt” is for dumb people

November 18, 2009 · 34 comments

Screen shot 2009-11-18 at Nov 18, 2009, 7.45.23 PM

I was facebook chatting yesterday with one of my loyal readers. She was discussing her car loan, when I mentioned my student loan. She said “At least your student loan is ‘good debt’.” She put good debt in quotes because she knows (and I know) there ain’t no such thing as good debt (did you know ain’t IS a word?).

Typically student loans and mortgages are considered good debt. Why? The thought is, with student loans you obtain a degree, and with a degree you get a higher paying job. For mortgage, you take on a loan, buy a house, and sell the house for a profit. Nice idea right?

Have you read my blog’s title? Is it Punch Bad Debt In The Face? I don’t think so suckers. There is no such thing as good debt. Debt is debt…period. A degree doesn’t guarantee higher income, no more than your home guarantees increasing in value. So don’t fall for the trap and think you should keep Sallie Mae around for the 20 year visit she is planning to take.

It’s time to change the classification of debt. There is bad debt (which we all know as credit cards, payday loans, etc) and not-as-sucky-but-still-pretty-crappy debt (student loans, mortgage). Whoever decided to call some debt “good” was a genius. Heck, I wonder how much money that label has made the banks. Probably at least ten dollars :)

Don’t get me wrong. I’m not opposed to utilizing debt to get an education or buy a home. In fact, I’m 99.9% sure I will take out a mortgage. But don’t trick yourself in to thinking that your mortgage is good. It should still be seen as a money hungry beast that won’t go away until you MAKE IT go away. Were you like me and once thought  “good debt” existed? If I could go back in time, I probably would have gone to a public college, saved a ton of money, and graduated debt free. Oh to be young, naive, and easily influenced.

p.s. Anyone that thinks student loans are “good debt” is more than welcome to have mine :)

1 SAM

Thanks for pointing this out, Ninja. When I decided to go back to graduate school, I was horrified at the thought of taking out $100k in loans to cover tuition and living expenses over the next 2 years.

Instead, I kept my job, where I still work full time and also receive a small ($3500/year) tuition stipend from my employer. I attend school part time, so it will take me 3 1/2 years instead of 2 to get my degree, but I will graduate debt-free (and with 1 1/2 more years of work experience than if I had quit – double bonus). This option gives me a lot more options – once I graduate, I won't have to take a sucky high-paying job over a better low-paying job because I have to pay off student loans. Also, I won't have to worry about competing with a bunch of other new grads on the job market – I'll already have a job with an employer knows me, likes me, and will give me opportunities to climb the ladder.

2 Jessie

My student loans are up for grab as well – – any takers???

3 FABULOUSLYBROKE.COM

Hey, agreed.

All debt is bad debt in my eyes. No debt is good, even if it only sucks away 1% of interest.

It's still 1%! It's like throwing 1% of your debt on the floor for them to pick up just because you can.

I dunno about you, but I pick up pennies all the time.

If anyone says: A penny is worthless

I tell them to give me a million pennies.

4 PunchDebt

How long do you think it would take to pick up a million pennies?

5 Brian

About a month, assuming you pick up one penny per second for 8 hours a day. If you take weekends off, that would push it up to about six and a half weeks.

A useful way to think about millions and billions is with time. One million seconds is a little over 11 days. One billion seconds is about 34 years.

6 duddes02

Agreed. Having student debt hangs over me just as much as having credit card debt would. Yeah, I have 20 years to pay it back but the math on how much interest I will pay is insane.

7 Kyle

Why is debt always bad. Can Simone not have debt and still be fiscally responsible, happy, and enjoying life? While not having debt may be ideal I don’t think the elimination of debt is necessary to be considered financially responsible or “free”.
.-= Kyle´s most recent blog ..Is Debt Really What is Keeping you Down? =-.

8 PunchDebt

I don't think debt is always bad, like I mentioned I plan to take out a mortgage. But, it is throwing money away that could have been used in more efficient places. I definitely don't think having debt makes someone financially irresponsible….shoot I have debt, but I think I'm pretty responsible. You can have debt and be responsible, or you can have no debt and be responsible. I'd prefer the latter option.

9 Money Funk

So, did you see my article about the costs some people pay to buy a new home? Ridiculous. I now know not to only ask, "what is the interest rate?". I also need to figure out or ask, "how much will this house cost me in 30 years?". I can't believe over a million dollars for a $365K house. *tish*

BTW, I may try picking up a million pennies. Hmmm…

And I am looking for takers on my student loans, too. Although, at an interest rate of 3.125% it's a loan I should have traded for paying cash. I was being totally financially irresponsible in my young adult life.

10 PunchDebt

Shoot, I never really thought about that. Maybe I am obligated to stay in debt for as long as I want to blog. Haha, yea right. I'll think of something to rant about :)

11 SS4BC

This is why you're getting a mortgage, silly. So you can punch your mortgage in the face. ;)

12 PunchDebt

touche

13 Money Funk

LOL.

14 CanadianDebtGirl

Hey, if you had your student loans from RBC in Canada, you could be debt free by now!

http://wp.me/pwpVp-25

Ridiculous.

If it weren't for student loans, I would not have been able to go to school. But I really wish I had just opted to go to college locally, then upgraded to university after my two year diploma was finished. More qualifications, less money, and likely would've been able to pay it all off while going to school. Ah, the brilliant benefit of hindsight… ;)

15 Donnie

Ninja, what are you going to write about once your debt is all gone? You can't be punching it in the face if you don't have any!

16 SS4BC

Sure, debt is always bad. But that doesn't mean that it is economical to pay off all debt. No, really.

For instance, my student loans are at a ridiculously low 2.26% fixed rate.

At that interest rate I am better off maxing out my IRA than putting that money on my student loan. I'm better off putting my money in index mutual funds than paying off my student loans.

Sure debt is bad, but sometimes the best FINANCIAL choice is to not pay it off. Especially if you can get back 5-10% from the market on the money that would be going to pay off a 2.26% debt.

17 PunchDebt

I totally agree with you on the IRA saving opposed to low student loans. I mean after all, I haven't paid off my loans in full even though I could. Let me ask you a question though, would you take out a 2.26% bank loan, to invest it in your IRA?

18 SS4BC

Absolutely not. I also wouldn't take out my student loans again. If given the choice I wouldn't borrow.

But given that I already have taken out my 2.25% loan (and thus far haven't found a way to turn back time and tell myself NOT to take out the student loan), I have to make the best of the situation that I am in. In this case it means paying more than the minimum – but not putting all of my effort towards paying it off like I would a debt greater than 5%.

19 @27andfrugal

I don't see my student loan as nearly as scary (even though it's 3 x's as much) as my credit card debt. My student loan is very low interest and that interest is still tax deductable for me.

While I wouldn't call the loan "good", it certainly is not as stressful as my other debts and I wouldn't be where I am in my life today if I never took out the loan.

20 Wendy

I agree. I think the fact that it doesn't seem as threatening and stressful as cc debt or other debts for that matter leads more people to feel good about classifying it as "good debt". Before I starting taking an interest in personal finance blogs, I too was under the "good debt" mentality but I'm slowly changing my ways. PD, you example of taking a bank loan to invest in your IRA made a lot of sense.

21 myprettypennies

Just want to say liked the article and agree with all you said. :) And I've got $3500 in 0% interest student loans if anyone wants to take that good debt off my hands. :)

22 RainyDaySaver

I despise all debt and want to punch it in the face! And beat it around the head and chest a bit, too. Luckily, I don't have student loans, thanks to the combined miracle of a full scholarship. But I definitely advocate paying off student loans before taking on a mortgage.

23 SS4BC

Heh… I also had a full scholarship (and free room, board and books)… and yet I still took out a student loan. All to buy a car! It was one of the worst decisions I've made…

24 JoeTaxpayer

I suspect people tried to separate the debt into the two groups as a way of pointing out when one really shouldn't use it. You don't have cash to buy a TV? Don't watch TV until you do. Going to school on the other have is an investment in one's life and career. While I don't call buying a house an "investment", few can ever buy one with cash. It doesn't mean the debt is 'good', I'd like to get rid of that monthly payment as much as the next guy, it just doesn't imply wreckless spending. Our mortgage was for about twice our income, and the payment about 15%, well below what they told us we 'should' borrow.

25 @MoneyMatters

I can't tell you how many times I've heard about this distinction between good and bad debt – and how everyone feels pressured to take on "good debt" in the form of student loans, mortgages, etc even if they don't necessarily need to.

Yes, I understand mathematically that sometimes having certain types of low interest debt are mathematically better because you can invest at a higher rate – but I think a lot of the time people discount the psychological aspect of having debt. It really is a weight on your shoulders, and getting rid of it feels so good! Being debt free is oh so much better!

26 WellHeeled

Debt is a tool. Too much student loans is bad, just as a unsustainable mortgage is bad, just as high levels of credit card debt is bad. I don't think debt should be demonized – it's a tool and as such, can be used for the right reasons or the wrong reasons. And most people think taking on a certain amount of debt to buy an education or a house is a "good" reason, hence the "good debt".

27 TSF

I'm with you, Ninja. Debt sucks. Some people might call my student loan and mortgage debt "good debt" because it's all under 5% (though some is variable), but it's still over $1,000 that comes out of my pocket each month — and I shudder to think how much it will cost in interest over the years.

That said, I think there is some value to prioritizing debt (whether you call it "good debt" vs. "bad debt" or rank it in terms of the amount of your balance, a la Dave Ramsey, or by interest rate, etc.) in order to determine how to pay it off. I'm still figuring out my plan for what to pay off when, and when/whether, relative to this payoff, I will begin saving/investing more, but at the end of the day, I'm with you — I want to just punch debt right in the face!

28 Wendell

I've always considered any debt that allows me to take a tax deduction to be "good debt". It's a silly rationalization, but any little bit of what I pay off that comes back to me is a "good" thing. You never get your credit card debt payments back. Sure, maybe I only get a portion of my mortgage interest back, but I live in a house (I HATE apartments/attached homes. Never had a good experience.) and to get even 10% of that interest back only sweetens the pot.

My student loans suck – especially because I went to a crappy school, had half my credits transfer and still ended up taking $40K in loans. The $2K interest I get back (if that…), makes me classify that loan as "bad" debt.

Long story short – I think classifications of debt as "good" or "bad" are truly a personal decision. One size does not fit all when it comes to our tolerances for certain types of debt.

29 livinglargevegas

Sorry but without student loans my spouse and I would not have been able to have the careers we now enjoy. That said, I believe private students loans are the worse consumer product this side of a payday loan. I borrowed about 100K and was in college 12 years. Adjusted for inflation and keeping in mind the low APR, that was some of the cheapest money I could have borrowed…I mean paying back 1988 dollars with 2005 dollars was a great situation (at least for those of you who understand nominal verses real dollars… )

30 livinglargevegas

oh, all of my student loans were subsidized none were private.

31 @billda

Disagree, there is *absolutely* a distinction between good and bad debt, and a mathematical one at that – no guesswork or ethical judgments needed.

In order to make the distinction, you need to first determine your own personal "opportunity cost of capital". This is a fancy economics term for the return you earn on money that you have saved. If all of your spare change is sitting in a savings account, your opportunity cost of capital is probably around 1%. If you have it in bonds, probably around 3-4%. Stocks, ~8%.

You can now make the distinction – if you can borrow at a rate that is BELOW your opportunity cost of capital, that debt is GOOD DEBT. Since I have historically achieved +-10% annual return on my savings (equities mostly), I would gladly borrow $1 million tomorrow (if someone would lend it to me) at any rate below 10%. I would then take the $1 million and invest as I usually do, pocketing the difference between the interest rate I borrowed at and the 10% return I receive on the invested $1 million.

This is why most people consider student loans and mortgages to be "good debt" – their interest rates are typically very low because they are either asset backed (mortgage) or government subsidized (student loans). It makes more sense to put your spare cash into an investment that earns 10%, rather that eliminating a debt that costs 5%. Follow?

32 PunchDebt

Try selling that to the people who took on “good debt” thinking their home would appreciate and now are facing foreclosure. Or to the people who’s stocks dropped by 50% in a relatively short time. When you take on debt (good or bad) you take on risk. If you like to play the odds then that is your game, but that doesn’t mean a mortgage is “good” it just means it is “less bad”

33 @billda

Obviously you are correct – with debt comes risk. I am NOT advocating borrowing to play in the stock market – just trying to illustrate the point. Taking on a large mortgage hoping a home will appreciate is exactly the same as borrowing to play the market – you are betting the housing market will go up. Quite risky, as many have discovered.

Remember, when buying a house you've essentially made a gamble – you've borrowed at a certain rate in order to invest in the home – you are betting the price of the home appreciates at a higher rate than the interest rate on the loan. If this appreciation doesn't materialize, what has actually happened is you have incorrectly estimated your opportunity cost of capital – you expected the home to increase in value more than it did, and now you have lost money on the investment.

You need to realize that your personal opportunity cost of capital should be a risk-adjusted average – i.e. the rate you expect to earn over the long term (well technically, the life of whatever debt instrument we are talking about – so 30 years for a mortgage). That's why even if you have earned 25% in the stock market this year, you should not use that amount as your opportunity cost of capital – you should still use ~8%, which is your expected LONG-TERM return on invested assets. This 8% accounts for the average of both your +30% years and your -20% years – it is a long-term rate of return.

Notice I did not say a student loan or mortgage is inherently "good" debt, only that they are USUALLY CONSIDERED "good debt" because they typically have lower interest rates. It all comes back to the comparison to your own personal opportunity cost of capital. It is different for everyone, and estimating accurately is the whole key here.

34 PunchDebt

I guess we differ in that I won't consider my home an investment. I have blogged about it before, but a home's primary purpose should be for living. The investment side is just a bonus in my eyes. I would never buy a home simply because I think it's a good investment. So buying a home for me is not really a gamble. It's a necessity, that could possibly return my money to me down the road.

I think you and I actually agree, we just use different terminology. I understand why student loans and mortgages could be argued called good debt, I just simply choose to refer to them as "less sucky" debt. Either way it sounds like we both have similar goals, just different strategies.

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