On today's show we talk with several financial experts about 'good debt', 'bad debt', and whether a distinction can be made between the two.
Since this topic usually brings out a strong diversity of opinions, we decided to talk to several past guests including Pat Foran, CTV television's Consumer Reporter and author of The Smart, Savvy Young Consumer, Robert Brown, author of Wealthing Like Rabbits, and Robin Taub, Chartered Accountant, financial literacy consultant, speaker, blogger, and author of A Parent's Guide To Raising Money-Smart Kids and Dr. Lee Anne Davies, a financial consultant with an MBA, master's degree, and PhD who also co-authored the book When Life Bites You In The Wallet - Taking Control Of Your Finances.
It's Not Black and White
1. Debt Is Unavoidable
Pat and Robin echoed a similar message; it is almost impossible to live without debt in today's world. So when making decisions about spending money, consider whether the purchase is a 'good debt' or a 'bad debt'.
Good Debt - Money spent on assets that will appreciate in value and can be used to increase your wealth. For example, a mortgage.
Bad Debt - Money spent on consumer items that will depreciate in value. For example, clothing, entertainment, or a vacation.
Sometimes the distinction is a little grey, like in the area of stock investments. As Pat points out,
making a stock investment can be 'good debt', or it can be bad if it goes south.
Robin put forth the same message, She stated that,
...I think in life you can't really avoid debt; because for the purchases, substantial purchases in your life, you're going to need to borrow money.
Even if it's good debt, the cautionary message was don't over leverage yourself. Avoid buying a home that consumes too much of your income in order to keep up with the payments because expenses can increase. Emergencies happen, condo fees increase. Pat talked about some real life examples of why this is such a great risk in the current Toronto condo market.
2. Extending The Traditional Definitions For Good and Bad Debt
Robert's approach to 'good debt' included many of the same ideas that Pat and Robin mentioned, but took those traditional definitions of debt even further. Robert summed up his theory stating that,
not all good debt is good and not all bad debt is bad.
He explained that debt is not the same for everyone and that an individual's personal circumstance can dictate whether a debt is good or bad. For example, a car loan can be classified a 'bad debt' because the car depreciates in value. However, if that person needs the car to get to work, to make money because they live 30 km outside of the city, it was money well spent for their situation; in other words, it becomes "good, bad debt". Similarly, Robert gives the example of "bad, good debt". If a house does not appreciate like anticipated, although seemingly a 'good debt', the mortgage has now become a 'bad debt' because it will not add value to the owner's wealth. Although these descriptions are oxymorons, they take into consideration those grey areas that the traditional outlook on debt may miss.
3. An Opposing Opinion About Debt
We heard from Pat, Robin, and Robert about what constitutes a 'good debt' and a 'bad debt'. To get a different opinion, I spoke with Lee Anne about her take on debt labeling. Her opinion? There is no such thing as' good debt'.
She explains that debt is almost always impulsive and that she believes in having a good plan. Look at the big picture and focus on your plan for repaying the debt. Make it flexible to accommodate unforeseen events, but only borrow with a goal in mind to protect yourself from falling into a large debt trap. Lee Anne touches on what she calls the housing wealth effect. As she puts it:
We’re very delusional about this. We think that the house is going to keep increasing in value. Well it isn’t
The need to buy a bigger and better house not only ties up all of your wealth in one asset (which can lead to financial issues), but also, that satisfied feeling has no long term effects because it works as a cycle. She asserts that we buy a house that we think will appreciate in value so we ignore the fact that we have payments to go along with the house, our confidence goes up and so does our consumption rate.
My Two Cents
If you can avoid debt, avoid it. You pay no interest and you can never get behind on your payments. Your life may not be fancy, but it will be stress free.
Taking on debt is a choice. The right choice may be different for different people. The best thing that you can do is to do your research, run the numbers, and make sure that you can afford to take on the debt. I explained in the show that 100 years ago, my grandfather was 16 and just starting out. He didn't have lines of credit or a credit card and he didn't have debt because back then, everything was paid for in cash. It's possible to survive without debt; but no one said it will be easy.
The number one thing that consumers should do before taking on any kind of debt, is to THINK. That advice sounds like common sense but the truth is, impulse spending is all too common. We could avoid a lot of debt by thinking about whether the purchase is necessary and affordable.
So is there 'good debt'? There is certainly bad debt, but as we've heard from each of our experts, what constitutes 'good debt' is still up for debate. The important piece of advice that all of our guests included in their time with me, is that debt should not be taken lightly. Think about the purchase, choose the most affordable option for you, make a plan to deal with the debt, follow that plan, and avoid impulse spending.
Resources Mentioned in the Show
- Lee Anne Davies' book, When Life Bites You In The Wallet - Taking Control Of Your Finances
- Pat Foran's book, The Smart, Savvy Young Consumer
- Robert Brown's book, Wealthing Like Rabbits
- Robin Taub's book, A Parents Guide To Raising Money-Smart Kids
You can read the full transcript from our good debt versus bad debt podcast here
How do you manage your debt decisions? We'd lover to hear from you. Leave us your thoughts in the comments section below.