Is there still such a thing as ‘Good Debt’?
Once upon a time, in a land that seems far, far away from the one we inhabit now, my generation was raised to believe in something called “good debt.”
Like a fairy godmother or a handsome prince, “good debt” was considered a path to prosperity, a foolproof way to invest in your own happily ever after.
In today’s economic climate, many have argued that “good debt” is the ultimate trickster, a kind of Rumpelstiltskin that exists only to lead good people astray.
But “good debt” is not some legend of days gone past. With a lot of good up-front research, you can make the right kind of borrowing work for you.
Good Debt: A fairy tale tradition
So, what is this “good debt,” anyway? Past definitions varied a bit.
Some experts considered a good debt one that let you write off the interest (from a low fixed-rate loan, natch) or get some other kind of tax break.
Others referred to good debt as one that had a high, if not guaranteed, rate of return.
But taken together, the overarching characterization of good debt was one that allowed you to invest in your future for better financial security.
“The idea is that if you took on a debt, there would be a return of your money over time. It was a long-term investment,” says Howard Dvorkin, founder of Consolidated Credit Counseling Services Inc. “So a good debt was anything that you could invest your money and supposedly get a larger return over time, like a college education, an advanced degree or a mortgage.”
A Man and His Castle: Changes to the housing market
When my parents and grandparents bought their first homes, it was assumed that they’d stay put for at least 20 years, if not forever.
“When you are buying a house and planning to stay in it over the course of 20 years, you are probably going to see some growth out of that house and the value of the house increase,” says Dvorkin.
That’s what made mortgages historically such a good debt.
But times have changed.
Dvorkin says we only stay an average of seven years in our homes. And we know now that property values peaked in 2006. Can mortgages still be considered a “good debt” after years of falling home prices?
Dvorkin says yes — there are still homes that are appreciating in value across the country, though perhaps not at as high a rate as they once were. He suggests doing a lot of up-front research and looking for homes that have maintained their value despite the housing crash.
Jon Hanson, the author of Good Debt, Bad Debt: Knowing the Difference Can Save Your Financial Life (Penguin Group, $12.95), adds that skyrocketing rent prices might actually make a home a better buy now than before the economic downturn.
“This is a buyer’s market, and there are some great homes you can find at a tremendous discount, so you are paying a lot less for a house payment each month than you would for rent,” Hanson says.
But he agrees that you need to do the math and make sure you’re financially stable enough to make those mortgage payments before signing on the dotted line.
From Student to Master: Changing career paths
Americans are drowning in student debt. We now owe more on college loans than on our credit cards.
The Federal Reserve Bank of New York estimates that the average student borrower now owes $23,000 and 3% of students owe more than $100,000, leading some financial experts to argue that student loans have definitely fallen out of the “good debt” category.
Many attribute this crisis to skyrocketing educational costs as well as the fact that more people are going to college.
But students are also approaching their career paths differently than they did in the past.
While our grandparents, and even our parents, were likely to stick with a single career over the course of their working life, people today are more likely to jump around a bit. No one wants to still be making payments on an undergraduate degree in art history when they are trying to figure out how to pay for a master’s in education.
So, given these changes to job markets and career paths, are student loans still a good debt?
Once again, Dvorkin says yes, provided you do your research and consider that loan as a long-term, small-return type of investment.
“I saw an article the other day that said a college education, over the course of a person’s lifetime, will help them earn a million dollars more than someone without a college degree,” he says. “But you have to think long-term. And understand that, in some fields, you may not get to see a return on that money for decades.”
Hanson agrees and adds, “You need to ask yourself what kind of job you can get with that degree, how much you’ll make, how much you’ll have to pay each month for the loan, where you might have to move to get those jobs. All the things that tell you that a degree is going to earn its keep.”
Avoiding the Big Bad Wolf: Strategizing debt
Hanson says that the four main effects of any debt are loss of freedom, loss of cash flow, loss of time and loss of opportunity.
“Debt affects your life. My quip is always that the past is the past unless you still owe for it,” he says. “You don’t want your debts to tie you down and make it so you can’t seek out newer and better opportunities.”
Given the changes occurring to both the housing and job markets today, that flexibility is important.
Ultimately, none of us have a magic mirror to see the future or a spinning wheel that can transform straw to gold. Planning for a future we can’t predict is no easy task.
But Dvorkin and Hanson say that a financial happily ever after isn’t the impossibility that this economy sometimes makes it out to be, provided you do your research, keep your expectations in check and minimize your risk.