What Is Good Debt?

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Who is worse off – someone with $200,000+ in debt or someone with $25,000 in debt? The answer? Of course it depends! It would be difficult for someone to rack up $200k in credit card debt but relatively easy for them to accrue that much in a mortgage (I am carrying a $225k+ in mortgage) but that’s what experts call good debt. Alternatively, it’s not terribly difficult to rack up $25k in credit card debt but that’s what experts consider bad debt. However, debt refers not to what kind it is (mortgage, home equity line of credit, credit card, personal loan, student loans, etc.) but the reason you incurred the debt in the first place.

Good debt is when you borrow in order to buy a necessity and don’t have the cash (or don’t want to tap into the emergency fund) to pay for it up front. You don’t want to go into the emergency fund because when you desperately need to tap into it, you need to have the cash there because banks only lend you money when you don’t need it. Bad debt is borrowing money to buy something that isn’t a necessity, like using your credit card to buy that new television. With American households owing around $9k each on their credit cards, you can see that many folks are carrying around bad debt… really bad debt.

Finally, add to the good debt those funds you borrow at a low interest rate and lend out at a higher one. The easiest example is getting those 0% balance transfer deals and then putting the funds into a 4% Emigrant Direct savings account, but even those arbitrage deals have some inherent risks.

{ 3 comments, please add your thoughts now! }

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3 Responses to “What Is Good Debt?”

  1. Matt says:

    I tend to categorize it a bit differently.

    Good debt is debt incurred for the purchase of goods which either appreciate in value over the life of the debt, or else provide ongoing operating value in excess of the cost of servicing the debt. (Mortgages on a primary residence win both ways, since houses almost always go up in value over the life of a mortgage, and the cost of renting an equivalent property would usually be higher than the cost of the mortgage payments. Mortgages on a secondary house are only good debt if the value of the house can be expected to rise. Car loans, on the other hand, are only good debt if they meet the utility criterion.)

    Bad debt is all other kinds, whether the purchase was “necessary” or not. (Note that by this definition, using a credit card to buy something can only become bad debt when one fails to pay off the card on time, regardless of how “unnecessary” or even “frivolous” the purchase may be. It’s still technically debt, but as long as you retire it within your creditor’s grace period, it’s _free_ debt, and hence any utility at all derived from the purchases made with it will push it into the realm of Good debt.)

  2. hafiz says:

    Everyone has their own definition of good and bad debts.

    I used to categorize my education loan as a bad debt because of the effect it has on my net worth. but come to think of it, when the borrower doesn’t punish you for minimum payments and the loan itself is a fixed interest over 20 years, it has to be a good debt.

    why? 20 years down the road, i owe them what i signed on the dotted line plus the interest. and inflation doesn’t affect this loan.

    is it considered as a good debt? i think it is.

    good post!

  3. debtmaster says:

    I have to agree 100% with the “good debt” definition by Matt.

    “Necessary debt” is a better way to describe things like student loans.

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