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Call You Tell Good Debt From Bad Debt?

Contributed by mm | March 16, 2005 11:24 AM PST

We are a nation that is obsessed with debt -- no question about it. In Fed's last tally, we have accumulated a total of $2,121 billion in consumer debt, including $801 billion in revolving debt (credit cards, store cards, etc.) and $1,320 billion non-revolving debt (auto loans, college loans, etc.) -- that does not even include mortgage debts. With a bit short of 300 million people in this country, we are talking about over $7,000 each, and our debt load is climbing at an annual rate of $92 billion a year ($300 per capita).

It is, therefore, no surprise that many want to capitalize this market opportunity by teaching us how to manage debts. A recent example is Jon Hanson, who wrote Good Debt, Bad Debt: Knowing the Difference Can Save Your Financial Life (selling for $14.93 at This book is pretty extensively covered by many newspapers (USA Today, Chicago Tribune, to name a few).

Long story short, Jon is essentially group debts to two categories (excerpt from Chicago Tribune):

- Good debt helps you gain assets that produce income. If taking out a loan will eventually put you in a better financial position, it's probably good debt.
- Bad debt lays claim to your cash, but it doesn't produce any cash flow. It's money borrowed for something that loses value."

I totally agree with that. After all, how can you argue with these statements? In post mortem perspective, a good financial decision is always one that brought favorable financial results, and a bad one is what resulted in something undesirable.

The real question is, is there a simple way beforehand that can tells a good debt from a bad debt?

The conventional wisdom is mortgage and student loan are good debt: mortgage helps you to buy a house that might appreciate over time, and student loan (or, to be exact, the education it finances) improves your earning power in the future. On the other hand, car loan and credit card debt are usually categorized as bad debt.

Not so simple! I can list many quick examples where a common-sense good debt can turn bad, and vice versa:

When Good Turns To Be Bad:

- A mortgage on an over-priced house or a mortgage that extends the borrower too much can be evil. Think about those who experienced foreclosures.
- College education is important, but a student loan to achieve certain degrees might not necessarily bring favorable financial concequences. Take a look at the value of some academic degrees; a few diplomas may not pay off in the long run.

When Bad Can Be ... Good:null

- Under certain circumstances, a 0% APR car loan can be a better deal than taking an upfront cash rebate. (Some analysis here and here.)
- Speaking of credit card, usually keeping revolving balance is not a good idea, but again, it does not hurt to exploit free money from 0% APR deals if you can fetch one.

See, actually you cannot tell whether it is a good debt or a bad debt by the loan type itself. What's really important, is the decisions that trigger those loans. At the end of the day, we'd better think all kinds of loans as the tools that are available to us, and it is how we use those tools that can make us or break us.

This Post Has Received 15 Comments. Share Your Opinions Too.

Michael Commented on March 16, 2005

Have you read the book? If so, what'd you think?

mm Commented on March 16, 2005

No, I haven't. I was just commenting on the fact that good debt vs bad debt is not a clean cut.

HELOC Commented on March 17, 2005

Sounds like an interesting book I'll need to pick up (at the library). Does the author have much to say about heloc debt? Assuming you are financially responsible and your purpose for borrowing is "good", it's hard to match the features/flexibility of a home equity line of credit. Yes, I know your "house is on the line" but if you're relatively secure in your ability to produce an income, the pros far outweigh the cons. I've been able to use my heloc on many occassions to produce positive financial outcomes where other debt forms simply wouldn't have been flexible enough to work. I consider it "good" debt.

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