Good Debt Versus Bad Debt

By Mike Cona on May 26, 2022

Over the course of our lifetimes, most of us borrow money at some point. Whether it’s to buy something as large as a house or as small as a cup of coffee, paying with cash or check for our purchases isn’t always possible, or even preferable. Some investors avoid debt at all costs. We’ve noticed numerous financial books or programs that focus on helping consumers become debt free. But not all debt is the same – in fact, some types of debt are better than others. Let’s take a look…


Mortgage Debt

Mortgage debt is used by most people to buy the home they live in, but it can also be used to purchase second homes, investment properties, or commercial real estate. Because these loans use property as collateral, the interest rates are typically low and the repayment periods can be very long. Mortgage debt is generally regarded as good debt, because it is leverage used to purchase an asset that historically has tended to appreciate over time. Also, depending on your situation, you may be able to deduct your mortgage interest on your tax return. Plus, with mortgage loan interest rates being so low, it often works out better financially to pay down other debt or invest excess cash, rather than pay off a mortgage ahead of schedule.


Home Equity Debt

Similar to a mortgage, a home equity loan or line of credit is a way to borrow against your equity, or ownership, of your home. These loans can be used for home improvements, consolidating higher-rate debt, or just for general liquidity. Interest rates for home equity borrowing tend to be slightly higher than mortgage interest rates. Home equity loans typically are for a fixed period of time and have a fixed interest rate. Home equity lines of credit, however, usually have a variable interest rate, but come with the flexibility to repay and reborrow over the life of the line. Home equity debt can be beneficial if used wisely to create long-term wealth, but may be harmful if used to encourage over-spending.


Student Loans

Student loans have been a very popular topic in the news lately, and have become increasingly common as the cost of college has ballooned over the past few decades. Interest rates can vary, depending on the lender, and there are often a few different repayment options. As a borrowing tool, used wisely to facilitate an education that can lead to career advancement, student loans can be good. However, taking on too much student loan debt without having a plan in place to repay it can lead to years of large payments that can prevent saving for other financial goals, like buying a home or even retirement. One thing to note about student loans is that they are very rarely discharged in bankruptcy. However, there are some programs and career choices that can lead to student loan forgiveness, provided certain requirements are met.


Auto Loans

Because buying an automobile is a large purchase, a loan is often necessary. Since these loans are collateralized by your vehicle, their interest rates are often very low for borrowers with good credit. From an interest rate perspective, it may be better to borrow to purchase a car rather than to sell investments and pay cash. Automobiles typically depreciate over time which means that you are really paying for the use and features of the vehicle rather than investing in an asset that you expect to appreciate. Programs and options can vary widely, so do your homework before committing to buy or lease. Since there are fees and expenses related to the purchase of a vehicle, we would generally encourage our clients to hold on to each vehicle for longer time periods. Also, consult your tax advisor regarding any incentives or tax benefits you may be eligible for.


Credit Cards

Credit cards are an essential part of everyday life for many people. Major credit cards are accepted for the vast majority of purchases these days, and the convenience of using credit cards can also come with perks like cash back and airline miles. However, like any other tool, there are pitfalls to avoid, and credit card debt is generally considered bad debt. Sometimes, the ease of using a credit card can make us forget that we are actually spending money, or even creating new debt, which can lead to overspending. Also, if credit card balances are not paid in full each month, the interest rates charged on these balances tend to be much higher than other forms of borrowing. If care is not taken, credit card balances can snowball very quickly, and can be difficult to get back under control.


Putting It All Together

While there is no shortage of opinions regarding the positives and negatives of various types of debt, we understand that each family’s situation is unique. If you or someone you know has questions regarding how best to use or manage debt while working towards reaching longer-term goals, please reach out to a member of our team. We will be happy to explore strategies involving borrowing and debt repayment that may help you better navigate your financial life.