Is there a such thing as good debt?
If I have to categorize debt, I would say the debt I am paying for, it's bad debt. A debt someone else is paying for, it's good debt.
Which means, if I have a mortgage on my house and I am paying for it. It's a bad debt.
Thought?
Good debt is debt which pays for an income producing asset. That is, income from the asset pays the debt and leaves profit after.
Bad debt is debt which pays for a liability. The item itself produces no income and does not enhance your net worth.
The loan on your home is not entirely bad since it provides you with shelter while the equity build-up enhances your net worth at the expense of the interest you pay. The interest still provides a deduction against your taxable income, also.
My $0.02...
Good debt is debt which pays for an income producing asset. That is, income from the asset pays the debt and leaves profit after.
Bad debt is debt which pays for a liability. The item itself produces no income and does not enhance your net worth.
The loan on your home is not entirely bad since it provides you with shelter while the equity build-up enhances your net worth at the expense of the interest you pay. The interest still provides a deduction against your taxable income, also.
My $0.02...
Borrowing to buy property or other ASSETS that hold their value or appreciate = Good* debt.
Borrowing to pay for items that are losing value and/or cannot be sold for profit = Bad debt!
Moral of the story: Always get rid of bad debt FIRST, and QUICKLY! Cheers...
* Good, in instances where borrowing is the only way forward to INCREASE your net wealth!
There is no such thing as good debt. All debt is bad. The idea that some debt is good and some is bad is an insane misconception dreamed up by student loan enthusiasts.
However, it sometimes makes sense to take on a liability if it allows you to purchase an asset that grows faster than that liability. This is a risk that you take. If the asset fails to produce, the debt is still the bad part that will bankrupt you (i.e. see student loans again). If it succeeds, it is the asset that created the success. The liability only enables you to purchase the asset.
The asset is good, the debt is bad. They are distinct and separate. Don't apply characteristics from one to the other.
It all depends on how the item financed is valued AND if it can be paid for responsibly. My ATV is a liability and bad debt to some, but I love it and didn't have to spend 7,000 of my capital to have it.
Responsible debt = good debt, everything else is bad.
That's a bit extreme, to my mind.
To me, student loans are a "speculative investment". You take on the debt hoping you'll be able to leverage that into enough income to repay the debt. Bad debt, to be sure, because you're depending on getting hired as a W2 as opposed to taking the initiative to use what you've learned to build a business and an income for yourself.
If I can borrow money at 4% and lend it back out at 12% or better, I'm getting the spread as income with, essentially, no "out of pocket". That's called arbitrage.
Good debt is debt which pays for an income producing asset. That is, income from the asset pays the debt and leaves profit after.
Bad debt is debt which pays for a liability. The item itself produces no income and does not enhance your net worth.
The loan on your home is not entirely bad since it provides you with shelter while the equity build-up enhances your net worth at the expense of the interest you pay. The interest still provides a deduction against your taxable income, also.
My $0.02...
If this was Quora, this would be the definitive top answer to your question.
If I can borrow money at 4% and lend it back out at 12% or better, I'm getting the spread as income with, essentially, no "out of pocket". That's called arbitrage.
Of course, but that doesn't make the debt "good". The debt was necessary to enable the purchase of the 12% asset, but the debt itself is still a liability on your personal balance sheet and cannot be described as anything but a negative to your total net worth.
The reason I say this is because it's important to not overly simplify for those who don't understand the financial numbers. For the uninitiated, they hear things like "mortgage debt is good debt" and then over-leverage on an underperforming D asset, and then are surprised when the home ends up in foreclosure thinking "what did I do wrong?"
Debt is always bad. If it enables you to purchase something that makes up for that negative, it is a strategic play to incur that bad item on your balance sheet to add an even better good item to your balance sheet, but the debt itself will never be anything but bad.
I'm sure you've heard it said, "You can't fix stupid". I don't see that as a reason to throw one's pendulum like that. People who don't know better will always make bad choices. That's why I'm in the education business - to save as many as I can (from themselves!).
By that measure, if debt is bad, then equity (net worth) is worse. If it doesn't produce income, it shrinks at a rate of roughly three times the rate of inflation. You can't pay bills, fill the car, buy groceries, etc. with either equity or net worth...
Cashier: That'll be $24.50, please.
You: I'm worth $1 Million.
Cashier: Great! That'll be $25.40, please.
Hey @Joe Au,
Despite what @Frank Jiang says, not all debt is bad. In fact debt can be very good. Debt can mitigate risk. Debt allows you to get into more and larger deals. Debts can build your portfolio faster and safer than all cash.
First, debt allows you to use less of your own money. The less of your investment capital at risk the better. Next, debt provides a solid form of asset protection. When combined with asset isolation your exposure is generally limited to your equity in the property under attack. The greater your debt the lower your exposure. I know insurance can protect you too. You should have insurance, but policies have caps. You could be sued beyond the limits of your policy and then they go after your equity. You can protect that capital by placing it into more isolated assets, spreading your risk and increasing your ROI (return on investment.)
Debt is leverage. Leverage can be good, very good. The most successful investors use leverage. Debt supporting positive leverage is good debt. Debt support negative leverage is bad debt. Leverage can amplify your investing capital, which can increase your income and net worth at the same time.
It amazes me how often an all-cash investor will buy investment properties without any financing, but still buy their personal residence with an 80% bank loan. Go figure!
The bottom line. Yes, debt can be good or bad. As others, like @David Dachtera, previously pointed out, good debt supports assets that put money into your pockets. Bad debt takes money out of your pockets.
I hope this helps.
Cheers!!
@Frank Jiang wrote
I don't agree but it is a mater of perspective. I look at it a tool. I can use a hammer in a bad way to smash a windshield or a positive way to build a house. Debt is a tool. It can give you positive leverage but always adds risk.
@Frank Jiang Unfortunately many times debt and the asset are not distinct and separate things. Because often without the debt, there would be no way to purchase the asset. The debt is a necessary condition, and in a closed system such as this you must view the two as one distinct item.
Money is neither good, nor is it the root of all evil. Money is money, and nothing more. It is only what you do with money that is either good or bad. Debt is simply a lack of money, and as such is neither intrinsically good or bad. It is only what you do with that debt that makes it good or bad. Debt in some instances can be a wonderful tool to produce a specific desired outcome. In this case it is referred to as good debt because it allowed you to achieve a beneficial outcome of which you would otherwise not been able to achieve.
What ever suits you financially. Decide whether you want to hold cash or equity, or leverage for income.
Why yes, there is indeed Good Debt. A Good Debt is a debt that helps your taxable estate, increases your credit rating, improves your total equity interest, and is something that you can shoulder for an extended period of time without the danger of a default. Wealthy individuals routinely utilize debt planning as a means to strengthen their net worth.
Some examples of good debt may include; refinanced student loans, a low interest credit card you pay off immediately and frequently, etc.
Disclaimer: The above is my financial opinion, nothing legal about it.
@Joe Au you are asking a question that doesn't have one answer, although many defend their opinion on this subject as though it is fact.
When you read books that study millionaires, the common theme is that people reduced debt and reduced expenses to gain wealth. I am not talking about Rich Dad Poor Dad or other books that tell you how to get rich. I am talking about books that interviewed multiple millionaires to find out what people actually did to get rich. Good books on this subject are Millionaire Real Estate Investor or Millionaire Next Door. The vast majority of millionaires got there by controlling their spending and aggressively paying off debt. It makes sense because to be a millionaire means you need to have a million dollars in assets. If I owned a million dollars in real estate and owed $900K to the bank, my net worth is only $100K. Most millionaires use debt to gain wealth, but they are also quick to get rid of debt. For that reason I think most wealthy people would say debt can be used to gain leverage and to get ahead financially. They would probably fall short of calling any debt good. Maybe necessary or helpful, but not good.
Why yes, there is indeed Good Debt. A Good Debt is a debt that helps your taxable estate, increases your credit rating, improves your total equity interest, and is something that you can shoulder for an extended period of time without the danger of a default. Wealthy individuals routinely utilize debt planning as a means to strengthen their net worth.
Some examples of good debt may include; refinanced student loans, a low interest credit card you pay off immediately and frequently, etc.
Disclaimer: The above is my financial opinion, nothing legal about it.
A wealthy person is not focused on increasing their credit score, wouldn't have student loans and wouldn't carry any credit balance on a credit card. Also the argument of taking on debt for tax purposes is flawed logic. I have heard accountants recommend mortgages for the tax deduction. That is like saying, I will send you $100 and you send me $25 back. Yes, estate planning needs to consider taxes, but that is different than taking on debt.
When I was young I had a retail job. A guy came in to purchase a computer and we had a promotion to get 15% off if you opened a charge card. The man said ok, but the quick approval denied him the credit card. He laughed and explained that he had millions of dollars in the bank and yet couldn't get a credit card. He still got the discount and just paid cash. That was one of my exposures to the idea that the wealthy don't focus on the same things that the working class does.
@Ned Carey You beat me to it! That is exactly what I was going to say - debt is a tool - but my tool of choice was a knife.
In my opinion, it is rather silly to talk about "good" debt and "bad" debt, as if debt were a pet that either obeyed your commands or misbehaved. If I cut myself, do I blame the tool, (bad knife!) or myself for mishandling it?
Debt is a tool. Like a hammer or knife or gun, it can be dangerous. It can also be useful. It is the user and the surrounding circumstances that determine the outcome of its use.
Why yes, there is indeed Good Debt. A Good Debt is a debt that helps your taxable estate, increases your credit rating, improves your total equity interest, and is something that you can shoulder for an extended period of time without the danger of a default. Wealthy individuals routinely utilize debt planning as a means to strengthen their net worth.
Some examples of good debt may include; refinanced student loans, a low interest credit card you pay off immediately and frequently, etc.
Disclaimer: The above is my financial opinion, nothing legal about it.
A wealthy person is not focused on increasing their credit score, wouldn't have student loans and wouldn't carry any credit balance on a credit card. Also the argument of taking on debt for tax purposes is flawed logic. I have heard accountants recommend mortgages for the tax deduction. That is like saying, I will send you $100 and you send me $25 back. Yes, estate planning needs to consider taxes, but that is different than taking on debt.
When I was young I had a retail job. A guy came in to purchase a computer and we had a promotion to get 15% off if you opened a charge card. The man said ok, but the quick approval denied him the credit card. He laughed and explained that he had millions of dollars in the bank and yet couldn't get a credit card. He still got the discount and just paid cash. That was one of my exposures to the idea that the wealthy don't focus on the same things that the working class does.
Well, I wouldn't go so far as to say that all wealthy people focus on the same things you just outlined, but it is definitely what old wealth focus on. I would disagree that new wealth, or aspiring wealth, shouldn't focus on increasing their net worth through creative tax schemes and debt leveraging. That is definitely what I have been doing, and it eases the burden of my self-employed taxable estate. Whereas I may normally have had to pay back taxes, I have been able to leverage my debts into a refund. I could have paid off my student loans a year ago, but have refinanced and kept it with a private lender to claim that sweet, sweet student loan credit.
I think there are degrees of wealth, and yes, to some extent you are right. But I also think there are some classes of wealthy individuals who these kinds of estate planning tricks actually work. I would qualify them as the few middle to upper-middle class individuals that still exist, but are trying to leverage their way into the 1%.
Also the argument of taking on debt for tax purposes is flawed logic. I have heard accountants recommend mortgages for the tax deduction. That is like saying, I will send you $100 and you send me $25 back. Yes, estate planning needs to consider taxes, but that is different than taking on debt.
If only more people understood this! I have heard people fret about paying off their mortgage because they would no longer have the tax deduction. I tell them to just make a donation to their favorite charity equal to what their mortgage deduction would have been. They can then claim the same deduction on their taxes, and do some good at the same time. For some reason, this usually just confuses them.
@Ned Carey, @David Dachtera, @Joe Splitrock, @Sylvia B. - and many others who are giving an honest yet flexible answer on the query:
I'll toss in one more perspective.
Everything is permissible for me, but not everything is beneficial. Everything is permissible for me, but I will not be mastered by anything.
You can accumulate debt or refrain from owing a person a dime. Either way, you deal with debits and credits every day. So whether you want to label it good or bad, you are engaged in acquiring debt and using your credits to service it every moment of your life (when you sit down for a nice dinner out with your sweetie, you incur a debt that must be paid at the end of that meal. It is an extremely short-term debt, but it is an obligation to pay).
Dining out is a fine thing. Could you save money by eating at home so you do not have to lay cash on the table before you retire to your comfy chair? Sure, is dining out worth spending that money? That's up to you. Should you dine out every day for every meal at the most expensive places? Should you always stay at home eating beans and rice and use candles and have no cable or furniture?
Ha.
It's all in moderation and with an understanding that YOU determine the value of that debt/tool/bill. My realtor is always fond of asking me, "what's it worth to YOU" when we're in the negotiation process for a new property. The amount is often relative based on what my vision is for the property and what I want to do financially with the property and in the future with it.
Can I make a mistake by acquiring too much debt/paying too much for something? Sure. Can I miss opportunities by not being willing to incur just an extra $2000 on a mortgage to secure a very profitable property from another investor? Yep.
Make your moves based on an over arching standard of investing; it is a rules based game grounded in hard numbers.
As cold as that sounds, it can still be fun! If the numbers make sense and keep you positive, then enjoy the game and move forward. If the numbers do not make sense, don't berate yourself about good or bad use of your money. Take it somewhere else to energize and grow.
Do not be mastered by the money, it is neither good or bad. It is bad not to have any! Use it as a tool, do not love it, do something good with it and enjoy the process, Joe!
Why yes, there is indeed Good Debt. A Good Debt is a debt that helps your taxable estate, increases your credit rating, improves your total equity interest, and is something that you can shoulder for an extended period of time without the danger of a default. Wealthy individuals routinely utilize debt planning as a means to strengthen their net worth.
Some examples of good debt may include; refinanced student loans, a low interest credit card you pay off immediately and frequently, etc.
Disclaimer: The above is my financial opinion, nothing legal about it.
A wealthy person is not focused on increasing their credit score, wouldn't have student loans and wouldn't carry any credit balance on a credit card. Also the argument of taking on debt for tax purposes is flawed logic. I have heard accountants recommend mortgages for the tax deduction. That is like saying, I will send you $100 and you send me $25 back. Yes, estate planning needs to consider taxes, but that is different than taking on debt.
When I was young I had a retail job. A guy came in to purchase a computer and we had a promotion to get 15% off if you opened a charge card. The man said ok, but the quick approval denied him the credit card. He laughed and explained that he had millions of dollars in the bank and yet couldn't get a credit card. He still got the discount and just paid cash. That was one of my exposures to the idea that the wealthy don't focus on the same things that the working class does.
Well, I wouldn't go so far as to say that all wealthy people focus on the same things you just outlined, but it is definitely what old wealth focus on. I would disagree that new wealth, or aspiring wealth, shouldn't focus on increasing their net worth through creative tax schemes and debt leveraging. That is definitely what I have been doing, and it eases the burden of my self-employed taxable estate. Whereas I may normally have had to pay back taxes, I have been able to leverage my debts into a refund. I could have paid off my student loans a year ago, but have refinanced and kept it with a private lender to claim that sweet, sweet student loan credit.
I think there are degrees of wealth, and yes, to some extent you are right. But I also think there are some classes of wealthy individuals who these kinds of estate planning tricks actually work. I would qualify them as the few middle to upper-middle class individuals that still exist, but are trying to leverage their way into the 1%.
I understand, so you are referring to the aspiring wealthy. I agree a good tax strategy and debt management is critical. Most studies of millionaires actually show that hardly any millionaires are old money, meaning inherited. High wage earners are not automatically wealthy. You have to measure assets, specifically equity in the asset. The best exercise is a personal balance sheet, which I recommend for everyone. This will calculate your net worth. I would expect a wealthy person to have at least $1M net worth, which isn't very much today. Of course age figures into that too. If a 25 year old has $500,000 net worth, it is arguably better than a 65 year old with $1M.
Keep in mind on your student loan credit. it only reduces your taxable income. Your tax rate is probably somewhere under 22% and the maximum student loan credit is $2500. That means your taxable income is reduced by $2500 and 22% of that is credited back. The maximum reduction in taxes you could get would be $550. In other words you paid $2500 to get back $550. Hopefully you see my point which is that you still paid $1950 in interest.
Debt = risk. Sure, we can add risk to the balance sheet to help us leverage into a property. It can be OK to do that, but it incurs risk. Good debt/ bad debt? I agree its all bad debt. I would love to own what I have, but I have debt and the associated risk. @David Dachtera , people liked what you said, but the example of net worth paying for groceries is a logical fallacy because if you have no debt (and that high net worth), you could buy the whole grocery store, without crawling to anybody to ask to borrow.
Is it worth it (i.e. Good) to take on risk for a reward? Yes, its absolutely what the free enterprise system is about. Take on lots of risk? Not a long term success strategy, or is it.....
I challenge you to find one successful person on this site that hadn't used debt. Of course there is good debt. The spread scenario above is the simplest way to explain it. Yes, you need to be careful with debt, but I don't think you fully understand debt if you believe it is more risky. In fact, when you mention someone doesn't pay, now you are bankrupt, you are referring to improper reserves, not a debt issue. You are in the same ballpark if you lose your job. Take a guess how many things have to go wrong with 50 leveraged buildings or 200 or more...
Looking for a risk-free investment?
When you find one, it will be better for you than winning the lottery.
Saw this in a head-hunter's office on a past job search: "Consider the tortoise who makes no progress until he sticks his neck out."
Investing = risk.
Can't take the heat? Stay outta the kitchen!
@David Dachtera I think we are in agreement. We realize that you have to take chances sometimes. less risk, less profit. My preference is to not build with max leverage, even though some call it 'good debt'. I have two homes paid for cash. Life has ups and downs, and the downs won't rock my world as bad, hopefully.