Hey Taylor – I’ve lived my life without ever taking on debt because my mother raised me to think it was pure evil. Now that I’m a young professional, I meet a lot of people who seem to be living well with a fair amount of debt to their names. So, is it all bad? Or should I be less afraid? – Paul
Hey Paul – If a parent is going to instill a financial lesson, there’s nothing wrong with teaching that debt is bad. That said, not all debts are created equal. If you’re financially savvy, there’s such a thing as good debt and bad debt, and knowing the difference can really change your outlook.
–1. Debt as an investment. Good debt is the kind that helps you grow your wealth or improve your life over time. Think of it like planting seeds—you’re borrowing money now with the expectation that it’ll pay off later. The classic example is student loans, provided the student is making good use of their time in college and pursuing a useful degree. No one loves making those monthly payments, but if your education leads to better job opportunities and a higher salary, that’s a pretty solid return on investment. A mortgage can be good debt, as can a business loan. If you’re buying something that enhances your future success, the debt might be worth the price.
–2. Debt for the sake of spending. Bad debt makes its presence known. It’s usually tied to things that lose value quickly or don’t give you anything back financially. The most obvious culprit, of course, is credit card debt. Every time you charge a fancy dinner or a weekend getaway without immediately paying the balance off, you’re losing money on interest and creating debt that’s only going to grow. This is the type of debt too many Americans are guilty of carrying, where the cost of the lifestyle they want to live is greater than the amount of money earned in a paycheck. If you budget and invest, and work hard, that financial freedom is totally achievable. If you try to live your dreams by using bad debt, you’re doing nothing but setting yourself up to fail.
–3. Context and interest rates. Every so often, it’s unclear whether a loan is good or bad. A car loan is bad when you’re buying more car than you need, but it’s good when it allows you to get to work reliably and increase your earning power. Interest rates also determine the value of your debt, as a big loan with low rates can allow your business to grow, whereas the same loan when rates are high might blow everything up.
It all comes down to judgment. Fortunately, since you’re predisposed to be wary of debt, I think you’ll do a good job with those judgment calls. It might be worth thinking twice before stretching your budget on a house or putting an entire vacation on a credit card. And when it comes to loans, borrowing with a clear plan in mind, especially if it helps build long-term wealth, could make sense. Thanks for the question!
Taylor Kovar, CFP®
CHIEF EXECUTIVE OFFICER
