Is There Such a Thing as Good Debt? Good Debt vs. Bad Debt

Posted in Money Tips
Posted by J. Douglas Hoyes, CA, CPA, LIT, CIRP, CBV

good-debt-bad-debtDebt is debt no matter how you look at it or how you want to look at it. Money owed is debt, whether it is for your education, a quick investment, or perhaps purchasing a home.

Conventional wisdom is that any debt borrowed to purchase something of value is “good” debt.  For example, borrowing to buy a home is thought to be good debt, because you get a house to live in, and when the mortgage is paid off you still have a house to live in.

That’s all true, but would it be good debt to buy a $10 million house with a $10 million mortgage?  If you can’t make the mortgage payments, that would not be good debt.

There are three questions you can ask to determine whether debt is good or bad (click here to see a video on good debt vs. bad debt):

First, can I afford the payments?  Even if you are borrowing to invest in a house or an RRSP, if you can’t afford the payments you have taken on bad debt.

Second, is there a long term benefit I will gain from borrowing the money?  A house or an investment is a good example, where the benefit will last long after the debt is paid.  Borrowing to go on a vacation is probably not good debt, because once the vacation is over, there is no further benefit.

Third, what risk are you taking on by borrowing the money?  You may buy a house with a mortgage you can afford, and the house will have a long term benefit, but will you be able to continue making the debt payments if you lose your job, or have your hours reduced at work?  How risky is the debt?  If you need to continue working 10 hours of overtime every week to make your debt payments, the debt is probably to risky, and should be avoided.

However, there are certain debts that can be considered good debts, because they add to the value of what you own or what you earn. As a result, debts such as college debt or a house debt are commonly accepted as good debts.

Why are such debts considered good? In some ways we look at whether or not the debt is considered responsible. It seems the responsible thing to do is to buy a house and have a roof over your head, but it doesn’t seem responsible when you overspend on your credit cards. Another common attribute of good debt, is that you may accept carrying that debt because you expect to be able to pay it back and expect that in the future you will be better off by having borrowed that money.

Debt is a tool.  On it’s own, it is neither good nor bad.  It is whether or not you are able to repay the debt that determines whether or not the debt is good or bad for you, in your unique situation.