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One of the biggest reasons for financial stress I’m seeing recently is the normalization of debt. This leads to many young adults being financially overstretched, and loaded down with student loans and consumer debt before they even start the real business of adulting.
I’m also hearing the phrase ‘good debt’ a lot in the personal finance space. But it’s being misused. Good debt is sometimes seen as debt that is taken out for a good reason, like education, or debt that is no- or low-interest, or debt that is helping you build your credit score (and regular readers know exactly how I feel about that).
That’s not how I define good debt, and it’s not how most personal finance experts define it either.
Like a lot of people interested in personal finance, I read Robert Kiyosaki’s Rich Dad, Poor Dad, at a fairly young age, and have always stuck to his definition of good debt and bad debt. Put very simply, bad debt is taken out to pay for consumption whereas good debt is taken out to buy assets. Bad debt leaves you with less net worth and no assets or income. Good debt is used to buy money-making assets, so it provides an income and increases your net worth over time.
The classic example of good debt, then, is property (commercial or residential) that can be rented out to provide an income while also, under normal market conditions, being an appreciating asset that can be sold at a later date. Good debt generates income. Bad debt doesn’t. Here’s why some of the debt referred to as ‘good debt’ really isn’t.
Student loan debt
Sure, it’s better to spend money on education than unnecessary consumer goods, but it’s still not necessarily good debt. The argument here is that you are investing in yourself, your greatest asset, and your education and skills will generate plenty of income over a lifetime. It’s a good argument, but not a flawless one. Your degree is not a source of (potentially passive) income, in the same way an investment property is. Student debt may be worthwhile and is inevitable for many of us, but it’s not good debt.
I’ve been told on numerous occasions that a particular debt is ‘good debt’ because the person going into it got a great deal on the interest rate. It is vital to compare loans and look for lower interest rates. And a low-interest rate is desirable when you have to take on debt, as long as the other conditions of the loan make sense for you, too. However, a low-interest rate loan still doesn’t qualify as good debt.
No interest debt
No interest debt is a great kind of debt, but it’s still not really ‘good debt’ and it can really trip you up, as it’s rarely interest-free forever. Interest-free deals tend to exist to lure you in. They persuade you to sign up for the financing or the credit card because you’ll get the first 12 months interest-free.
These deals can be great if you really can pay them off within the interest-free period. They’re not so great when the high-interest rate suddenly kicks in and the no-interest loan becomes a relatively high-interest loan. If you’re on a no-interest loan because you borrowed from a relative or close friend, that’s a good deal, but it’s still not, technically speaking, good debt.
Credit building debt
I’ve talked about this before. Building your credit score is not a good excuse to take on consumer debt. A good credit score can be really useful, but it’s best built organically, over time, by being aware of important issues such as your credit utilization rate and other sensible strategies that can improve credit ratings. Running up a ton of consumer debt to build a credit score just isn’t good financial planning, and it definitely isn’t good debt.
If you want to take on truly good debt, you’re going to have to find an income-generating, appreciating asset. All other debt is the type of debt you want to avoid when possible, manage carefully and pay down if you can.
About the Author
I’m a freelance writer specializing in online business, personal finance, travel and lifestyle. I also work as a content creator for hire, helping brands and businesses tell their stories, grow their audiences, and reach their ideal customers. I’ve lived, worked and studied in six countries, across three continents. Stop by my blog TheSavvySolopreneur.net to learn how to run your own (very) small business on your own terms. You can also connect with me at my website KarenBanes.com or follow me on Medium.com.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.