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Credit Management Home > Credit management > Some debt

Good debt and bad debt

The amount of personal debt is ever increasing, and a large part of the reason is that credit has never been easier to get. Whereas credit card issuers previously looked for customers who could repay, today card issuers relish the chance to reel in those who'll continuously charge beyond their means at 18 or 20 percent.

But debt is a complex concept. Not all of it is good -- a fact a surprising number of people fail to realize until they're in the hole -- and yet not all of it is bad. When used intelligently, debt can be of tremendous assistance in building wealth.


"When you buy something that goes down in value immediately, that's bad debt," says David Bach, CEO of Finish Rich Inc. and author of The Finish Rich Workbook. "If it has no potential to increase in value, that's bad debt."

Good debt
"Good debt produces cash flow, and bad debt doesn't," says John Waskin, CEO of Bill Free / American Credit Counselors, a nonprofit debt counselling service in the U.S. "If you go into debt buying an apartment building that will produce revenue and deductions, that's good debt. Mortgage debt is good debt. You're borrowing money, but you're getting a tax advantage and can write off interest on an asset that's appreciating over time. Plus, you get to live there."

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Robert D. Manning, a professor of finance at the Rochester Institute of Technology, also recommends taking on debts that are tax-deductible, and debts that produce more wealth in the long run.


These general rules of thumb set some clear delineations -- buying a home or refinancing to get rid of excessively high rates is usually good debt, as is generating debt to buy high return stocks, bonds and other investments.

Bad debt
The concept of bad debt comes in when discussing the purchase of disposable items or durable goods or, in general, the use of high interest credit cards.

"The problem is, people don't realize that credit cards are just plastic cash," says Chris Bender, Communications Manager for the National Foundation for Credit Counseling in the U.S.. "They think when they pay with credit cards they don't have to pay for it quickly, and so they don't keep track of what they spend.

"When you hand someone cash, it's a psychological wake-up. 'Why, I just gave away $40.' When you charge something, you don't see the money go, and in your mind that makes a difference."

But buying on credit isn't the same as buying with cash, because cash doesn't make you pay interest on items as they drop in value.



"Your debt-to-income ratio shouldn't go above 20 percent," says Rob Harol, Credit Card Category Manager at "If you find yourself above that, it doesn't look good on credit reports, even if you're making payments on time."



Exacerbating the bad debt factor is that people will apply for store credit for the savings, offers that say if you open a credit card account today, you can take 10 percent to 20 percent off the cost of your purchase. What people often don't realize is how much of that savings will be destroyed by the high interest rate on the card if they fail to pay for the items immediately.


Driving into debt

"People can afford to pay cash for a car," says Waskin, "but not the car they see themselves in from an ego extension standpoint. So you buy a car at a much higher rate than a house, and that asset is worth less the day you drive it off the lot."

Bach considers auto debt a Catch-22.


Harol reminds us that just a few years ago it might have made more sense to buy a car at 6 percent or 7 percent, and then invest in other avenues and earn 10 percent or higher on your money, than to pay off the car. Now, of course, with traditional market investments substantially riskier, that is no longer the case.





Bach cites some shocking numbers to back this up.



"This is the most advantageous time ever to be in debt," says Manning, "in terms of opportunities to get low income loans, or to renegotiate or refinance."

Duh, debt?
One of the reasons so many people seem mired in bad debt (both Bach and Waskin report that the average American carries approximately $8,400 in credit card debt) is that financial education is virtually non-existent.


"We are stupid people when it comes to financial education," says Waskin. "Only 40 percent of high school students receive any economic training. We don't teach kids how to balance a checkbook, what a credit card is, paying rent. We just say, 'Figure it out.'"


Waskin says that the way to fix this is to educate kids on the difference between good and bad debt, and to return to some basic fiscal common sense.

"We need to go back to the fundamental values our parents and grandparents had, saving for a rainy day," says Waskin. "The best thing you can do is hope for the best, but plan for the worst."

-- Posted: Jan. 9, 2003
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