May 2002
Good Debt - Bad Debt
Amy E. Gibb, MBA, CFP
I remember my first loan. I borrowed $2,500 on a student loan to go to college in 1979. It was a lot of money. This was back when a gallon of gas cost 59 cents and an apartment rented for $150 a month. It wasn't until after I graduated that the reality of that loan hit home. The payments started. I paid $35 a month out of my meager salary for money that was long gone.
When we are young, the ability to get a loan tells the world we are adults, ready for all the rewards and responsibilities of life. But, as we get older, borrowing money becomes part of daily life. We go to work just to pay the bills. The daily mail brings bills for car loans, home mortgages, second mortgages, credit cards, furniture loans and student loans. After the bills are paid, there isn't much left, so we borrow more to buy the things we want and need. This is the trap of "Bad Debt".
"Bad Debt" lures us by giving us what we want today, without a thought
for tomorrow. "Bad Debt" makes us poorer while "Good Debt makes
us richer. "Bad Debt" is used to buy things that we can't afford but
want NOW. It buys things that lose value quickly and the "Bad Debt"
continues long after what we bought is gone.
"Good Debt" is money we borrow to acquire things that grow in value
and generate income, like rentals and businesses. "Good Debt" is money
we borrow to increase our skills so we can earn more, like student loans. "Good
Debt" pays for itself and makes us richer.
Home mortgage loans and car loans can be either "Good Debt" or "Bad Debt". Mortgages help us buy homes that appreciate in value. There are tax breaks on the interest, taxes paid and on the growth in value. The "Bad Debt" trap happens when we refinance our homes and take out equity to buy more things, or we buy a house that doesn't fit our budget. Car loans can be "Good Debt" when buying your very first car to help you go to work to generate income. Car loans become "Bad Debt" when you use them to buy your second, third or fourth car, or to buy a car that is bigger then your budget.
On top of the "Bad Debt" list is credit card debt. This debt is usually for impulse purchases that are gone quickly. Lets say you go out to eat, and charge your $50 dinner or your credit card. If you make minimum payments on the credit card, it could take 10 years to payoff this meal and will cost you $100 to $150 by the time you are done.
"Bad Debt" makes us poorer by adding the cost of interest to everything we buy, in exchange for immediate gratification. Because of this interest cost, we have less money in the future to buy what we want. We then borrow again to buy what we want and it becomes a trap.
To get rid of "Bad Debt" we must delay buying things that we borrow money to buy, the new car, the new dress, and a new couch. Aggressively pay off "Bad Debt" as soon as possible and stop the "Bad Debt" trap. Cut up your credit cards, drive the car that is paid for while saving for your next car, pay cash for what you buy or don't buy it. After your "Bad Debt" is gone, you will be amazed at the extra money you will have left.
"Good Debt" makes you richer. "Good Debt" is money borrowed to buy rental real estate, to finance a business or improve your skills. This debt is usually for income producing investments that grow in value and produce income greater then the cost of the interest. If you borrow $100,000 to buy a rental property, which rents for $1,000 a month, and your payments and all your expenses don't exceed a $1,000 per month, that would be "Good Debt".
When I borrowed money for college in 1979, I didn't know that it was "Good Debt"; I just hated having less money to spend because of the loan payments. Since then, I have worked to stay out of "Bad Debt". If you need help getting rid of your "Bad Debt" contact your financial advisor or credit counselor. In the end you won't have less you'll have more.
Amy E. Gibb, MBA, CFP
President
Money $ense
Amy@MoneySenseSolutions.com, www.MoneySenseSolutions.com
303.494.5362
Financial Advising for individuals and business owners
"Money isn’t everything, Managing it is"
Amy E. Gibb, President of Money $ense specializes in helping people get out of bad debt and helps them manage their good debt. She may be contacted at 303.494.5362, or for more information go to www.MoneySenseSolutions.com.