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Good Debt - Bad Debt

Updated on December 17, 2011

What is Debt

People have a lot of opinions about debt.  There are many like Dave Ramsey (who I like a lot) that believes everyone should have plastic surgery.  Of course the plastic he is talking about is your credit cards.  There are others who totally believe in OPM (other people's money) and the more debt you can get the better (seems our government thinks this way of course that's another topic). 

What we will attempt to answer in this article is, "What is debt."  In the course of finding out what debt is we will also discover the difference between good debt, bad debt, and the benefits of being debt free or "in debt."

While many may proclaim that they are debt free this actually isn't true.  Just take a look at the debt clock in the link below.  You may not owe Sears or Visa, but none the less you owe.

Time to Define Debt

Many people define debt as owing money. I don't! I worked in finance for many years and had several thousand loans in the portfolio that I managed. Within those loans there we people that we never had to call as it pertained to the payments on their loans. There were others that we viewed as "owing us money."

You see there is a difference using other peoples money and paying a fee for that money and "owing" someone something. My mortgage lender never calls me because I never "owe" them money. When we contracted for the home that I live in we agreed that the payment that I would make for the usage of their money would be paid on a certain date. I don't owe the March 2011 payment, because it's not due based on our agreement. Therefore, that money, not being owed, is not debt to me.

However, if I miss the payment then they would call me and ask, "Where's the money you owe me?" They would have every right to do this since I did not give them the payment on the money they gave me.

Someone may think that I am splitting hairs on definitions, but this is actually important. The reason that this is important is for this reason. If I think that I have to never owe anyone anything to be debt free then I have limited myself to my own resources, which limits my ability to increase in income and wealth.

If you can accept this concept then we need to step further into the equation of debt. What is "good debt" and what is "bad debt?" There is a definite difference between the two. Our bankruptcy courts are full of people who have used bad debt to fund their lives and now find themselves in a financial pickle that they can't get out of.

In very simple terms, good debt will increase you and bad debt will decrease you. When you use debt to purchase an item that becomes worthless it is bad debt. Things like clothing, food, electronics, Christmas, vacations, etc will all become worthless. Therefore, when you use debt to pay for these items you not only have paid for items that are worthless, but you are paying extra for them in the form of interest.

This is where I totally agree with most of Dave Ramsey's teachings. People need plastic surgery because what they are using debt for is killing them financially. If those same people would get their debt paid off they would cut off all those enormous interest charges giving themselves an immediate raise. For this I give Dave Ramsey are very strong thumbs up and highly recommend his book, "The Total Money Makeover."

Good Debt

Good debt is just like the term says, "it is good."  In other words it helps you, increases you, and makes you stronger.  A home mortgage is good debt.  It is good in the sense that you now own your own home.  Therefore, instead of throwing money down the sink renting you are putting your money into something that will increase in value, help reduce your taxes, and give you a place that you can call your own.

However, there is even better debt than this.  What if my debt can make me money?  Let's play a game.  If you had a $50.00 bill in your hand and I had a $100.00 bill in my hand and I told you that if you gave me $50.00 that is in your hand then I would give you the $100 in my hand, would you?  Of course you would and you would think that I was stupid.  Now let's add a little time to the equation.  Let's say you have that same $50.00 in your hand and I had the $100 in my hand and I told you that if you gave me the $50.00 then I would give you the $100 next week?  Would you do it now?

In reality your decision would be based on how well you knew me.  Let's assume the confidence is there, in that case I am sure you would do it.  You would sacrifice the usage of the money for the 100% return on your money.

Now, a very important question.  Was I stupid?  Well the answer to that question all depends upon what I do with the money.  If I knew that I could take that $50 and buy a hose and some soap and wash five cars a day for $10.00 a car then it would be pretty smart of me.  Seven days would equal 35 cars times $10 would give me $350.00.  I pay you your $100.00 and still have $250.00 left.  Now, the "debt" actually gave me more money.

You may pose the question of why didn't I just use the $100.00 that I had.  Well, that would be a good question and my response would be why would I want to?  You see if I used my money then I wouldn't have had anything to live on.  I would have limited my lifestyle in order to achieve my goal. 

In my example above I gave you a 100% return in one week, but in reality you can get money and borrow at 4%, 10%, or 20% per year.  That's a lot less than 100% in one week.  If you could make 10-15% a month flipping money then who cares if you are paying 20% per year.

Let's assume that you have a house that you are all proud of that you own free and clear.  I would submit to you that you don't own it free and clear.  In reality you are paying dearly for this house.  If you can make 5% per month on your money and it would cost you 6% per year to take a loan on it then do the math. 

If you borrowed $100,000.00 and paid 6% in interest you would pay $6,000.00 per year in interest.  If you took that money and made 5% per month then you would receive $5,000.00 per month.  Would you pay $6K to receive $60K?  I think so!

I know what you are saying, "I can't earn 5% per month so what is the point of all of this?"  The point is you "can't" earn 5% because you don't have money.  If you had money then you would learn how to make 5%, 10% or 15% per month.  It is possible, but only possible for those who have money and know how to make it work for them.

Really what all this boils down to is education.  Most people are not willing to take a little time and money to find out how money works.  They will gladly take 40 hours of their week and trade it for $1,000, but not take 2 hours a week and find out how $10,000.00 will earn the same amount of money for them.

I don't know about you, but I would much rather have my money earning money then my time.  Trust me there are ways.  If you are not willing to take the time to learn how then loan your money to me.  I'll gladly give you 5% for it!


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      tiffani. 8 years ago

      you just know EXACTLY what i'm thinking.

      great minds think alike.