Credello: Could the So-Called 'Good Debt' Actually Be Bad for You?

Categorizing your debt as "good debt" or "bad debt" may offer some personal comfort when you're making monthly minimum payments, but those classifications are not always accurate. There are times when you can have too much debt, regardless of whether it's good or bad. An inability to pay what you owe is never a positive thing. 

There are instances where good debt can be bad for you. To understand this on a deeper level, let's look at four types of debt that normally fall in the "good" category. They are: 

  • Mortgages
  • Student Loans
  • Loans for Job Skill Programs
  • Business Loans

Classifying these as "good" all of the time is a trap that many borrowers fall into. They're not clearly bad, like credit card debt and payday loans, but there are circumstances when taking out a loan for a home, an education, or a business can hurt you.  

1. The Mortgage Trap

Once upon a time, home buyers could pay a certain price for a house and have the security of knowing that home value would go up at some point. In the 1960s, for instance, you could buy a home for $10K and then sell it in the 80s for ten times that amount. That is no longer the case. Home values are high right now and there's no guarantee they'll go up. They could go down.  

We're calling this one the "mortgage trap." Financial professionals classify mortgages as good debt because you're getting something of value when you take out the loan. However, if you're going to lose money when the property depreciates, it's not good. 

2. Education Doesn't Always Pay Off

The fast-food industry is saturated with the broken spirits of college graduates who went to school for the wrong reason. Paying thousands of dollars in student loan debt for a degree that won't score you a job is not a good move, yet those loans count as "good debt." They can be, but only if your education contributes to getting a higher paying job or a job in a specific field.

3. No Job is Secure Right Now

Loans for job skill programs could be good or bad. Diversifying your skill set could open up new opportunities for you, but what if you're in a dying industry? Technology and automation are making many positions obsolete. Training for the wrong job falls in the same category as choosing the wrong major in college, leaving you in a lot of debt with little options.  

4. Debt is Not the Only Way to Fund a Business

Americans are indoctrinated into a debt culture from an early age. We're taught that borrowing is necessary to succeed in life, so many first-time entrepreneurs look to fund their business through debt. That is often a mistake. MBA programs teach their students about concepts like "lean startups" and "equity sharing." These eliminate debt and businesses still succeed. 

Another often-overlooked consequence of business debt is that it shrinks profit margins. You're not getting free money to fund your business. The loan must be repaid, putting your business at risk of default if you can't come up with the money. It's better to stay lean, operate with no debt, and take on investors for an equity share if you need cash to expand.     

Try "Useful vs Useless" instead of "Good vs Bad"

It's nice to have a guideline, but the concept of "good debt vs bad debt" is outdated and inaccurate. The circumstances dictate the effect that borrowing will have on you. Instead of looking at the simplistic view, let's try evaluating each loan as "useful" or "useless." If the money you borrow will make you money, it's useful. If it won't, it falls in the other category.     

Source: Credello


Categories: Personal and Family Finances

Tags: Debt, Financial Services, Personal Finance

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