What is “good debt” vs. “bad debt?”

Hello, my name is Ron Blue. I’ve been asked many, many times: “Is there any good debt? Or is there bad debt?” And the answer is, “Yes, there is good debt, and there is bad debt.” Let me put it this way: there is some debt that’s better than other debt. And again, I’m defining debt as any amount of monies borrowed as debt. We’ve all heard of the debtor’s prison, and this is where people could not afford to pay their debts, and they were taken to jail. We don’t do that any more, but it certainly sent a moral message to people when it came to borrowing money.

So what’s the best kind of debt that you can have? Well, there are really only two economic criteria. Number one is that I must have a guaranteed way to repay. How am I going to repay the amount of money borrowed? Because, if you don’t have a guaranteed way to repay, then you’re violating the biblical principle of presuming upon the future. So, when you borrow money, what’s the plan of repayment? And, is it guaranteed so that I am not presuming upon the future? For example, if I take out a mortgage on my home, typically the mortgage document says that in the case of default, the bank (the lender) gets the home. There is a guaranteed way to repay, if you will, in a mortgage type situation. (With) consumer debt, credit card debt, you don’t have an out, if you will. You have to repay, you don’t have anything really to collateralize it.

And here’s a second (criteria) that seems so simple, so rational, so logical, but most people miss it. And that is: The economic return on the amount of money borrowed (in other words what I’m using it for) let’s again use a house, if I am borrowing for a house, is there some type of expected economic return that is greater than the economic cost? So, if I borrow on a home mortgage at 6%, for example, am I reasonably confident that the home will appreciate to cover the interest, at the very least? Now, until just recently, that has been a reasonable assumption to make. But a lot of people borrowed 100% or more on their real estate, on their homes, and now they can’t repay because the values have gone down, and are not going to be recoverable. But, if I have enough margin built in there, I still have a guaranteed way to repay, and I have had an economic cost to it that maybe is greater than the economic benefit. However, when I made the decision on a home, the economic benefit was greater than the economic cost. Those are the two rules to apply when it comes to borrowing money.

Consumer debt, credit card debt, is typically anywhere from 12 to 30 percent. So let’s say I go out to eat at a restaurant, and I spend $50 to take my family out to eat, and I put it on my credit card, and I don’t repay. I am going to be repaying that debt, with interest, at 12 to 30 percent. The economic return in that particular case certainly is zero. The emotional return may be okay, but the economic return of borrowing and using credit cards to fund lifestyle expenses makes no sense whatsoever.

Click here for the January 29, 2010 Blog Entry