Why I Don’t (Always) Hate Debt

In his blog post last week titled “Why I Hate Credit Scores,” my colleague Michael Smith wrote about his aversion to debt and why he wants to get to a point where he doesn’t care about his credit score. I generally agree. Debt can really get people (as well as businesses and governments) into a lot of trouble. We see that all the time in the people we help. That being said, I don’t think all debt is bad debt. Instead, I would argue that there are circumstances where debt can be a good thing.

Ideally, we would have enough in savings that we would never need to go into debt in an emergency, but that doesn’t always happen. Given the choice between a temporary loan and not being able to put food on the table, most people would probably choose the former. There are a couple of guidelines to follow though. First, make sure that it’s actually a genuine emergency. Too often, our definition of emergency expands into buying something that we really, really want right now but don’t really need. Instead, keep it limited to the basics of food, shelter, power, transportation, and health care. Second, if you have to borrow, at least try to choose the least of evils. Credit card debt is bad but pay day loans are even worse. You don’t want to turn one emergency into another.

Beyond emergencies, debt can make sense when it’s being used to finance something that returns more than what the debt is costing you. Businesses do this all the time. In fact, most probably couldn’t have started or even continue to survive without having access to credit.

The first example many of us are familiar with is taking a student loan to go to college. Yes, student loans are burdensome but it can be worth it when you consider that the average college grad earns almost $1 million more over their lifetime than a high school grad. (Whether every college degree is actually worth the price of admission is another topic.) A car loan can also qualify if you need the car to commute to work.

Mortgage debt is another classic example of good debt. Despite the recent housing crash, many people would still say that their home was their best investment. That’s because taking a mortgage allows you to build equity in an appreciating asset while making a mortgage payment that may not be much higher than your rent payment, especially after factoring in the tax deduction.  In addition, your mortgage payments can be fixed and will eventually be paid off, but your rent will continue increasing for the rest of your life.

Some people advocate trying to pay your mortgage off as soon as possible by making extra payments. There’s a good argument for the opposite though. Considering how low mortgage interest rates are, there’s a good chance you’ll get a higher long term return on your money by investing it than you would save by paying down your mortgage early. That may sound risky but having more savings and less home equity can actually be safer. After all, you can always use your savings to make the mortgage payment if you hit a rough patch. A lower mortgage balance doesn’t help you until it’s actually paid off and even then, good luck accessing the equity to cover your other bills if you lose your job. No one wants to loan money to someone without an income, no matter how much equity you have.

My point isn’t that you should run up a lot of debt or not worry about any existing credit card debt that you may have. High interest credit card debt can be  a financial killer. The point is that not all debt is bad. There are situations when borrowing money can make sense so keep an eye on those credit scores.

 

 

 

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