As soon as you start talking about debt there are people who want to make a distinction between “good” and “bad” debt. It’s as if they feel the need to justify the debt they’ve taken on by labeling it “good.” Hey, it’s true that if you take on debt to increase your income or build assets that can be worth the cost, but so many people miss the point.
Let’s take mortgage debt as an example. According to the rules of the game, mortgage debt is good debt. You’re building an asset right? Well, maybe. If your home appreciates to a greater extent than the debt you’ve taken. But you can’t simply compare purchase prices and sale prices. You also have to add in all the carrying costs associated with that mortgage like the interest you’ve paid and the insurance costs if you’ve used CMHC insurance because you didn’t have a 20% down payment. Also a mortgage is good debt as long as it isn’t too much mortgage and doesn’t put you at risk of default or doesn’t squeeze your cash flow so tight you end up buying your groceries on your credit card.
Student debt is good debt as long as you’re able to pay it back on the income you’ll earn when you graduate. As a rule of thumb, that means not taking on more student debt than your first year’s income after school. So if you’re in nursing school and when you get out in your first year you’ll earn $47,000, that’s as much student loan debt as you should take on.
One of the debts that’s positioned as great is the RRSP loan. I’m much more strict about this being good debt than most people. An RRSP loan is good debt only if you can pay off the loan in one year or less, save on taxes AND make your RRSP contribution for the next year. Otherwise, you’ve just gotten on the hamster wheel.
Business loans are good debt as long as the business generates income and stands a chance of making a profit.
Investment debt is good debt if you know what you’re doing, and are prepared for the risks associated with leveraging
A car loan is okay debt if you need the car to earn your income. If you’re an idiot and buy an out-of-your-budget vehicle by taking seven, eight or ten years to pay it off, that loan is terrible debt. You’ve got to get that puppy paid off as quickly as possible (three years or less).
I’ve heard people say that a line of credit used to finance home improvements is good debt. Hey, you should have had a home maintenance fund to take care of your most valuable asset. But using a credit line beats watching your home fall down around your ears. So if work must be done to keep the home healthy and safe, then do it, but make sure you get that line paid off lickety-split or you’ll turn it into horrible debt.
A consolidation loan isn’t technically “good” debt either, but it’s better than the alternative forms of borrowing as long as the interest rate is lower than you’re currently paying on the debts you’re consolidating AND you have the consolidation loan paid off in three years or less. Miss on that last point and you turned an okay idea into a bad idea.
Everything else is crap debt: credit card balances, overdraft, buy-now-pay-laters, the LOC you use for everything from vacations to home improvement for nice-to-have features, leases or loans on cars that take you above the 15% guideline for transportation, and – OMG! The worst: payday advance loans.
If you’re taking on bad debt, give yourself a good slap on the forehead. If your debt falls into the “good debt” category, and you’re being responsible about how you deal with it – keep your costs low, not dragging out the repayment period – then it’s a necessary evil and you shouldn’t beat yourself up over it. Just work hard to get it paid off as quickly as you can.