What is good debt? In simple terms, good debt is debt that pays for its own interest rates and generates additional cash flow and income. It costs you nothing in order to have the debt and it increases your net worth by generating excess cash flow for you to benefit from.
There are people who staunchly dislike debt to the maximum. People like Dave Ramsey, for example, who utterly cannot stand debt. However, the ones who hate debt are the ones who mismanaged the debt. Dave Ramsey declared bankruptcy because his debts were short term loans.
Once the banks who owned his loans saw a guy in his 20’s with multi million dollars in loans, the bank called in the debt at maturity, in which Dave Ramsey had no money to pay for in a short amount of time. In other words, he didn’t understand the debt he was taking on very well.
He was always living on edge with the debt and was at the mercy of the lender. He doesn’t understand that there are other forms of debt out there that doesn’t make people lose their shirts like they made him. That is where the term good debt comes in to play.
What is good debt? Good debt is debt that actually makes you money over the long term instead of bankrupting you. There are underlying characteristics on what makes up a good debt. In general it is that they have low interest rates, have long maturities, and have no prepayment penalties.
How Does Good Debt Exist?
Good debt exists because there are smart astute investors out there who figured out the costs of using debt in some instances are so low that it makes sense to use them to their advantage. There are lenders willing to lend at the low interest rates because the risks are so low as well.
Examples include mortgage debt, car loans, and borrowers with a good credit history. Banks figured out that mortgages can carry some of the lowest rates because borrowers need a place to live in to go about everyday life. So then how does this benefit the astute investors talked about earlier?
If they can figure out a way to generate cash flow that covers all of the expenses of owning a house and then some, then it’s profitable for them. This is the pinnacle and the underlying thesis of real estate investing. That’s the pinnacle answer behind the question what is good debt?
In 2020, we had record low interest rates that anyone has ever seen. It was as if the banks were paying the customers to take on debt. It was incredible. Some of my friends got mortgages at the 2.75% range. That’s absolutely insane! That’s how good debt exists.
There are times when interest rates are so low, that it makes sense for an investor to take advantage. The interest rates could be low through the Fed’s actions of lowering interest rates or the lenders thinking that the risk to lending out money is very low. It may seem counterintuitive but good debt exists.
What are Examples of Good Debt?
One example of a good debt is when you SMASH that social share button and post to your favorite social media! It takes a lot of time for me to research and write articles so if you could share for me, I would appreciate it.
So with that said, these are the examples of good debt.
1) Mortgage
Mortgages that give you a place to live in are good debt. Some mortgages were as low as 2.75% in 2021 and now the mortgages are picking up in 2022. Now, the average mortgage rate is around 4.31% as of April 2022, with expectations it will go higher.
The Fed is expected to raise interest rates to a high level in order to curb and control inflation. However, mortgages which provide you a place to live in is a great debt vehicle to have. In addition, it allows you to build equity in the meantime as well.
When people ask what is good debt? The first answer that pops up should be mortgages because they provide you a place to live in. I’m personally looking into buying a house but realistically, I know that I won’t be able to because the housing prices have increased too much. It’s become too late for me.
If I were to, I would definitely get a mortgage and feel great about it.
2) Business Debt
Business debt that makes you more money than the loan itself is a good debt. What’s wrong with taking on debt at $1,000 per month if the business generates $2,000 per month? There isn’t a whole lot of things that are wrong with that. Starting a business on a loan isn’t the most prudent of decisions, however.
What you should do is start the business with minimal capital and see if that works. See if you can get the business off the ground from the organic cash flow it generates. That’s the best business there is because it can stand on its own two feet without relying on outside funding to survive.
What is good debt if not debt that allows you to be your own boss, make more money, service customers, and the like? Some businesses took advantage of record low interest rates in 2020/2021 and are sitting on that low interest rate debt today.
Ford and Amazon are two companies who avoided the tech bubble crash and the financial crisis due to them taking on debt to survive and ride out the crash.
3) Real Estate Investing Mortgages
Mortgages in rental real estate properties give you excess cash flow on top of paying off the mortgage over time, which builds equity. It’s a good debt for people to take on. Now, the deals doesn’t always work. There are markets in which the properties do not cash flow.
The costs of holding onto the property are higher than the rental rates. Cities such as Austin, TX are becoming too expensive for real estate investors to buy cash flowing properties. However, that doesn’t mean it’s like that everywhere. Some cities are still cash flowing very well.
I personally wanted to go into the real estate investing strategy. However, it didn’t work out because I never was able to pull the trigger on any properties. I was too busy saving and investing my money in stocks and I still am. However, I am not blind to answer the question what is good debt with real estate investing mortgages.
4) No Interest Debt
Some credit cards are now offering no interest rate debt! What is this insanity! The downside is you will have to be some sort of an origination fee. The offer that I got the other day came with a 3% origination fee. Even though it’s non interest rate bearing, this is how the non interest rate debt companies are making the money.
When inflation is at 8.5% and climbing by the month, a 3% interest rate debt means that your debt’s value is eroding by 5.5% every year. When your money erodes, it’s a bad thing, but when the value of your debt erodes, that’s a good thing. No interest rate is definitely in the good debt category because the costs are so low.
When the Fed increases the interest rates, I expect no interest loans to slowly subside and be non existent in a number of years. However, while they’re still around, plenty of people have taken advantage of them. When the debt doesn’t cost you anything, then it’s not a bad idea to accept the debt.
5) Student Loans
Student loans for college can be a great idea. However, it completely depends on the kind of degree that you get. There are stories of people getting into be managing directors as a theater student. However, those stories are getting dimmer and dimmer by the year.
Fewer companies are willing to give chances to students who don’t study what their business is all about. Even though I believe college is a waste of time and money because there are better alternatives, that doesn’t mean that I believe that it provides negative value.
Student loans in which you invest in yourself, knowledge, education, and career is a good choice. I’ve been fortunate enough to have graduated with very minimal, $5,000, in student loans that I paid off after six months. Student loans for a degree that will be lucrative down the road is definitely an answer to what is good debt?
Additionally, I actually had the chance to take on zero interest, subsidized loans. However, not knowing any better, I rejected the loan offers. I should have never turned down an interest free loan. That’s not a shrewd financial decision.
What is a Good Amount of Debt?
The rule of thumb when it comes to a good amount of debt is when the cash flow you generate from your day job or investments can pay off the interest rates of the debt that you hold. That way, if the debt ever does go South, which is ALWAYS a possibility in this world, you are covered and protected.
Having more debt than what your day job and what your investment income can pay in your interest expenses alone is stressful. it’s not only stressful but it’s an enormous amount of risk that you can easily avoid. After you answer the question what is good debt, it’s time to answer the question how much debt is good?
There comes a point where you reach financial distress. Debt is generally a cheaper form of financing than other alternatives. However, debt isn’t free, it comes at a cost. There comes a point where even taking on more cheap debt is stressful and makes you worse off because it causes financial distress.
You don’t want to take on a million dollar’s worth of debt to find out your company is laying you off. There is no “safe” income source these days. Companies are willing to freely lay off workers if they’re not profitable. Don’t take on so much debt during the good times only to get burned down the road.
There are so many cheap debt offers these days because banks have more money than they know what to do with. Don’t get enticed. Even if the offers are very solid and financially beneficial to you, too much of debt isn’t worth the extra money that it can generate down the road.
What is Good Debt? They Are Out There
Dave Ramsey is absolutely wrong when it comes to debt. There are some debt that are WORTH having. Some debt that is good and beneficial for you, over the short and long term. These forms of debt exists and it’s in your best interest to take advantage of them.
If you’re asking what is good debt?, at the very least, you are asking the right questions for your financial future. Now, personal finance is personal. With taking on debt comes the psychological trap of knowing that you owe someone else money. It means you HAVE to work in order to pay that off.
Some people just absolutely cannot handle that and it’s better off for them to not take on any debt in the first place. Personal finance is incredibly personal and debt isn’t for everybody. However, that doesn’t mean that the tools and the characteristics to qualify for good debt aren’t out there.
Debt isn’t for the faint of heart nor is it for the people who doesn’t know what they’re doing. Before taking on debt, making sure your emergency fund is padded up is not a bad idea, as well. Remember losing money is hard. It’s even harder when you lose debt money.
It means you have to pay back your interest with money that you lost, money that no longer exists. While asking what is good debt is a good idea, also figuring out whether you are fit to take on debt in the first place is a great question as well. You don’t want to get burned.
