Debt can be a sensitive subject. There are those who firmly believe there is no such thing as “good” debt, while others look at it sort of like fire – it can be a useful thing as long as it's properly controlled.
So the personal finance website Credit.com this week asked the provocative question, “is there such a thing as good debt?” Answering its own question, it lays out five questions that must first be answered in the affirmative before debt can be classified as “good.”
First, a potential borrower should ask if going into debt is the best way to get something. If so, the borrower should determine whether the monthly payments are affordable.
Next, a borrower should look in the credit mirror to determine what his or her credit picture looks like. If it's bad, it means either being rejected for the loan or being saddled with an expensive subprime loan.
Now, ask how the payment will fit into a monthly budget. Will it end up taking away from grocery money, or a child's music lessons?
Finally, ask if you are borrowing money from a reputable lender. That's important for avoiding unfair terms and burdensome fees.
Spending future money
Debt, by its very nature, is inflationary. It makes something that is very expensive obtainable now, but does so at a cost.
Debt allows you to spend money you will earn in the future to purchase something now. Unfortunately, consumers sometimes lose sight of the paying-back part. But debt takes money from the future to pay for something today, meaning you won't have as much money in the future.
That's why it is never a good idea to go to a payday lender for $200 to meet an immediate need. In the case of a payday loan, the $200 has to be paid back in two weeks.
Where will that $200 come from? You don't have it now – which is why you are at the payday loan store. What makes you think you'll magically have the money to repay the loan in two weeks?
Nearly everyone borrows money if they buy a home. Here, you could make a strong case for “good” debt, as long as it makes more sense to buy than rent and you get a fixed rate, low interest loan. After all, you will pay something each month for putting a roof over your head, whether its is rent or a mortgage payment. In many instances a monthly mortgage rate is less than rent.
There is a bit more debate about going into debt to buy a car. After all, a car is a depreciating asset, meaning it is worth less the longer you own it. The danger is not putting enough money down and financing the vehicle over too long a term. At some point, a consumer could owe more than the vehicle is worth.
Besides the five questions Credit.com asks, here's one more. Does the thing I am financing have lasting value? That question can apply to a college education or remodeling a kitchen.
It's important because you are paying for something with money you'll earn in the future. Only, you won't be able to spend it on future needs because you'll be spending it to pay down your debt.