Good Debt vs. Bad Debt

Often the question of whether or not a person should have some good debt vs. bad debt. The problem is that there is really no such thing as good debt. There's debt that allows you to purchase high ticket items in a hurry; to own a home via a mortgage; to own a car via a loan; or to own stocks and bonds on margin. Technically, this is still debt, but because the actual value may be greater than the cost of the item, it could be classified as good debt.

So essentially good debt is debt owed on an item that brings more value into your life than it takes in the form of money paid out. For instance if your washer or dryer broke and then you had to make weekly trips to the laundry mat, you may believe it would be more cost effective to invest in another washer or dryer. This would be to avoid the trips to the laundry which require you to pack your dirty laundry and sit in a laundry mat for two hours each week for a total investment of three and one half hours of time and the cost of the machines. You're doing laundry for a family of five, so you need 8 machines to wash and dry. Each machine cost $2.50 per load and dryers cost 25 cents for 10 minutes and it takes about 40 minutes to dry one load for a total of $1 per load. The grand total is $28 per visit to the laundry. You also lose the 2 and one half hours you were able to devote to house cleaning. If you paid yourself $25 for the time, your total investment would be $53 times 4, equaling $212 per month. If you could find a washer that cost $139 per month, you would save money if you bought the washer with a credit card. This would be good debt and a wise expense to take assume.

Purchasing a home is not always good debt. If the numbers do not add up in your favor it could be a very costly mistake. If there is no equity in the house, the price is high and the interest is high, it is probably not a good purchase. If there is significant equity in the house and the price is reasonable for the actual value of the house and last but not least the interest is bearable, you may have gotten a bargain. When you decide to sell this home, you will hopefully make a profit even after paying interest for 30 years. That is called good debt.

Cars loose 30% of their value the moment you drive them off the dealer's lot. Since a car loan incorporates interest, you're never ahead of the immediate loss you incur. Consequently, a car loan is technically, not good debt. Stocks and bonds can grow in value. They can also lose value. Any investment that has the same opportunity to lose value as it does to gain value is not something you should borrow money to buy, unless you're a gambler. Gambling is not a good way to assume debt. All your investments should be based on an opportunity to gain from the investment, not an opportunity to lose.

Good debt is temporary debt which ends with you having gained more than you invested. Bad debt is just taking on an expense which you cannot pay all at once, because you don't have the money on hand. We buy cars like that, because despite the situation we still need to get to work to support ourselves and our families. Bad debt is simply debt we cannot avoid and debt that does not improve our finances at any point in time. Good debt vs. bad debt is obligations that put more money in our pockets than it removes at some point in time.