This is a guest post by Adrian J Cartwood of 7million7years.com, who shares his opinion on good vs bad debt. Be sure to leave your thoughts in the comment section below.If all debt was bad, surely it would make sense to avoid it completely?
I can’t explain why this is wrong without using a whole lot of boring numbers and calculations, so let me use food as an example, instead.
When considering a healthy diet, fat is considered “bad” so it’s best that you don’t eat any fatty foods, right?
Except that if you avoided all foods based on their fat content, you would avoid eating all meat, fish, and many vegetables, including avocados.
In short, you would probably starve.
So, you learn about the different types of fat: the sorts of fat that you get from fish and vegetables is good fat and you can – and should – eat it. But, trans-fat and animal fat is bad fat and you should eliminate it from your diet.
To stay healthy, you exercise – of course – and you avoid bad fat. Simple. Similarly with debt: it’s true that buying a stereo on your credit card is bad. But, not all debt is bad.
For example, would you really have been able to buy your house if you had to save up the full purchase price and pay cash? And, would you really have been able to afford to go to college if you didn’t get that student loan?
Clearly, some debt is good debt (e.g. your house and student loan) while other debt is bad debt (e.g. credit card consumer debt). And, it would stand to reason that a healthy financial life would entail paying off all of your bad debt as quickly as possible.
So, this is where current financial thinking is concentrated: on creating methods (such as the Debt Snowball) to eliminate this “bad debt” as quickly as possible. But, this is where our food analogy begins to break down; you see, this good debt and bad debt distinction only applies before you get into debt.
Once you have debt, it is no longer “good” or “bad”…it now becomes either cheap or expensive debt. It no longer matters what the loan was for, but how much it costs you every month in interest. It’s “cheap” if the interest rate is low (such as for student loans and home mortgages), and “expensive” if the interest rate is high (such as for credit cards, and auto loans).
Once you have some debt, you should first pay off your expensive debt as quickly as possible. After all, where could you find a better investment than paying off a 13% auto loan or a 19% credit card? But – using the principal that money saved is exactly the same as money earned – if you have a 2% student loan or a 4% mortgage, surely you could do better than paying it off?
Even when the stock market and real-estate markets are fluctuating, over the long-term you will earn far more by putting your money into investments, rather than paying off these low-cost 2% – 4% loans. Remember, it’s never a good idea to whip out your credit card to buy something that you can’t afford to pay for in cash. But, that doesn’t mean that all debt is your enemy.
Similarly, use the debt that you already have to help you get your financial life on track by considering how it helps – or hinders – you in making the kind of investment decisions that will help you improve the financial quality of your life.
Now that you’ve heard Adrian’s take, share your thoughts on debt in the comments below.
Adrian J Cartwood is a self-made (and, recently-retired) multi-millionaire and author of the personal finance blog “How To Make $7 million In 7 Years” where AJC blogs about his personal journey from $30,000 in debt to $7 million in the bank. AJC (in conjunction with popular blogger and author, Debbie Dragon) has just published his first book, “Share Your Number“!
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