The word debt is often tied to the idea of borrowing. With that relation in mind, we’ll discuss the differences.
Today, we hear “Debt is bad. Get out of debt. Pay down your mortgage. No debt is the way to go. Debt free living is a must for financial freedom.” I think people have really scared themselves about this topic.
But do you remember, back in the day, when we kept hearing that fat and cholesterol are bad? You’d find people at the grocery store looking at the labels to ensure they weren’t in the foods they were buying. Then when we got information that there’s good fat and good cholesterol, people’s heads were spinning.
The same holds true for debt. There are two kinds of it: Good Debt and Bad Debt. Plain and simple: When people use debt to buy assets (things that produce income for you), that’s good. On the other hand, when people use debt to buy doodads and liabilities, that’s bad. Can you guess what the rich do?
Good Debt is used to produce while Bad Debt is used to consume.
The Good
It is good when it can help increase your productivity and wealth. If you get into debt to purchase assets like real estate and use them to cashflow, then you are utilizing it to your advantage. The renter of the property is actually paying for the liability.
At the time of this article, my wife and I just enrolled for a coaching program given by Bob Proctor. So far, it’s been our most expensive coaching program. While we could use money from our emergency fund, we decided it’s best to keep our reserves in tact. Our next option was to use some of our cash value from our life insurance policies. But, we felt that when an investment opportunity arises, it’s easier to borrow from our policies.
The option we finally took was to charge it on our American Express Blue Cash Credit Card. While this may make some of you cringe, it made more sense to us to leverage someone else’s money. This money is being used to invest in us where the potential returns are limitless.
Rest assured, we have a strategy to pay it back.
The Bad
It is bad when you use it to consume. (Bad is a relative term in a sense that it is not used to increase your wealth.) Some use credit cards to fund a lavish lifestyle and get deeper and deeper in the hole.
I recently read that the average credit-card holding household owes almost $10,000 on their cards. If these balances are a result of destructive consumption, then these households are in trouble.
Credit card companies like college students. They charge a lot and usually pay the minimum because they have virtually no income to offset it. But I’m sure students love them too. They usually offer free stuff.
The Ugly
Let’s look at the example of the average household that has almost $10,000 in credit card debt.
Amount – $10,000
Payment – $200 per month
Term – 78 months
Total Interest – $5,790.32
Grand Total – $15,790.32
With a monthly payment of $200, it will take 6.5 years to payoff that $10,000. What makes it worse, the interest paid back is more than half the principal. Now, how ugly is that?
The Truth
Truthfully speaking, debt isn’t what everyone thinks it is. According to accounting, debt is when your liabilities exceed your assets. When your assets exceed your liabilities, that’s called equity.
Popular financial pundits like Suze Orman and Dave Ramsey say to eliminate all debt. They say avoid it. And I agree, because of the true meaning: liabilities > assets = debt. But this isn’t the definition they’re using. Their stance is that any kind of borrowing is bad. But as we have discussed above, if you borrow to produce more, then it’s good.
To put debt (or borrowing) on your side, here’s the formula:
Increase your liabilities to increase your assets to increase your wealth.
Debt can hurt you if used incorrectly and irresponsibly. But we’re using debt differently. We’re using it to increase our productivity and wealth. Use it only to your advantage.
If you can accept that there is good fat and good cholesterol, consider that good debt exists. Do you have debt that is weighing you down or debt that is helping you become financially fit?
