Certain “financial advisors” – who are little more than media-made celebrities – declare that debt is bad and must be purged. They have names that rhyme with Rave Damsey, Floozie Orsman, and Spark Coward.
There is partial truth in their words – but the whole truth is – not all debt is equal.
Debt is a commitment of future income for something we want today. The problem is that we’re not promised income tomorrow (or tomorrow itself for that matter). So – if the “thing” we acquire with debt either declines in value or is consumed – we’ve made a repayment promise we might not be able to keep – and that’s bad.
But when debt is used to acquire things that have a reasonable chance of holding their value – or growing in value – repayment doesn’t have to rely on future income alone – we can always sell the “thing” in a pinch to satisfy the debt.
Let’s look at a few examples:
- Debt to buy a house. Good debt – because the house is not consumed, is unlikely to lose value, and could be sold to satisfy the debt if need be.
- Debt to take a vacation. Bad debt – the vacation is “consumed” and there’s nothing to repay the debt other than the promise of future income.
- Debt to make an investment. A little tougher – because we have to assess the safety of the investment; and the likelihood of it growing in value. Safe, growth-oriented investments may be comfortably financed with debt – risky investments should not.
- Debt to get an education (here comes the controversy). Bad debt. Education is consumed (by the student) for the express purpose of securing a future income that doesn’t even exist at the time debt is taken on.
Bottom line: Assess debt for what it is. Borrow sparingly. Borrow only when you know – with reasonable certainty – that the debt will acquire something that won’t be consumed or lose value.