I was once told by a good friend that I shouldn’t be worried about paying off my student loans because student loan debt is good debt. He stated that I should just be paying the minimum payments and investing the rest. We both worked in finance, so I knew the thinking behind his point.
But to me, my student loans were not good debt. They were loans that hung over my head, that couldn’t be discharged by repossession or in bankruptcy. Even if I died, my dad would have to pay back the remainder of my private student loans – he was the cosigner after all. My student loan debt was not a “good debt” situation, no matter how “right” my friend’s point was.
To explain my friend’s thinking we need to ask the following: is there really such a thing as good debt? In short, yes. For some. It really depends on how you look at things. (I know, I know. That’s my favorite answer these days.)
In order to really get into the good debt versus bad debt battle, we should probably know what each one is.
Good debt can simply be defined as an investment that will grow in value over time. No, this is not your Gucci purse no matter how much the sales lady says “it’s an investment!” This definition is referring to things such as student loans or mortgages.
The money that you take out in the form of debt is put toward something that should make you money in the future. A college degree can get you a better paying job with the prospect of future promotions. A house gives you a place to live that should slowly appreciate in value year over year.
Both of these examples tend to come with low interest rates. And best of all, many times the interest is tax-deductible. In the past, I have been able to write off the interest I paid on my student loans (up to $2,500 – and yes I hit this almost every year) and my mortgage since I itemized my tax deductions.
Again simply put, bad debt is defined as money taken out as debt to buy things that decrease in value, such as auto loans. Credit card debt typically falls into this category. Financing items like a computer or furniture through a store falls into this category.
Bad debt normally comes with higher interest rates because this is the kind of debt that people tend to default on. Think about it. If you lose your job and have to make a choice between paying your heating bill or an installment on your sectional couch, which are you going to pay?
I am a big fan of avoiding most bad debt and most good debt. But this is where things get complicated…
When Good Debt is Bad Debt and Bad Debt is Good Debt
The simple definitions of good and bad debt can get messy very quickly. For example, I can argue that credit card debt is good debt as long as it is paid off every month. Using credit cards this way can gain me cash back points, airline miles, or other benefits without having to pay any interest.
I can also argue that good debt is not always good debt. Taking out student loans for a college degree should get you a well paying job with future career growth, unless you don’t finish that final year and therefore do not actually get that degree. Just because you didn’t graduate doesn’t mean you don’t have to pay back the loans.
Another example is housing. A house should gain in value. But many lost a huge chunk of value in the Financial Crisis of 2008. Many people who overextended themselves with loans taken out against their house value ended up losing their homes. Would you consider that good debt?
And seeing as how I’m currently tearing down student loans and mortgages, I should mention that with the recent changes to tax laws and the standard deduction, many people who would have itemized and written off interest rates associated with these kinds of debt will no longer benefit from itemizing. In short, for many tax-paying citizens, the interest write-off benefit of good debt just got signed away.
So Is There Really Such a Thing as Good Debt?
Again, yes there is. It’s all in how you tailor your finances. You have to be responsible when it comes to good or bad debt. No matter what. If you take out student loans, make sure you finish college. And take out as little as possible. If you take out a mortgage, make sure you can make the payments in good times and bad.
If you decide to incur so-called bad debt, only do so when you can pay it off right away. Pay off your credit cards every month and get those credit card rewards. If you don’t feel comfortable carrying around thousands of dollars in cash, then finance a car and then pay it off with the first payment you make. (I did this once and it shot my credit score up for a while.)
It’s up to you on how you want to handle your debt. Dave and I could pay off a significant portion of our house, but we’ve decided to invest that cash instead. This is our choice. We know that as long as our investments are making a better return than the interest we are paying in our mortgage, we are making money. We both have sufficient emergency funds so we are comfortable with this. You may not be.
So don’t let someone tell you that you shouldn’t be paying extra toward student loans because it’s good debt or that you shouldn’t be using a credit card because it’s bad debt. Good and bad debt is all in the eye of the beholder.