I probably won’t win any new friends with this posting. In fact, I’ll probably piss off my current friends and have to explain myself endlessly to my family. But I’m not sorry. I simply do not believe there is such a thing as “good debt”. In fact, I think anyone who argues for “good debt” either has something to sell you or needs to validate their own financial decisions.
Before launching into this anti-debt rhetoric I thought I should consult Google for a nice definition of “good debt” just to be sure I’m not living on planet nuts. I must admit, I’m very surprised with Google’s response: “No definitions were found for Good Debt.” Snicker.
Google aside, most people living on earth would argue “good debt” is money borrowed for purchasing things that retain, and hopefully increase in value over the long term. These things would include borrowing for an education (student debt), a home (mortgage debt), or for your own business (business debt). At the outset, these examples of “good debt” make very good sense. However, what this simple definition fails to consider is borrowing money for perceived gains is high-risk speculation. Since people get absorbed with perceived gains, they also seemingly fail to anticipate the other expenses incurred with so called “good debt”. Let’s consider each form of “good debt” in detail.
1. Student Debt
Many students graduate these days with massive debt incurred from post secondary education. School is expensive, and many students and parents don’t have the funds to send junior off to school. Then why my beef with student debt? It’s simple, when taking on education debt many students fail to consider if the subjects they study can bear the financial burden of debt repayment. Will students who take degrees in Psychology, English, or History be employable in lucrative enough jobs to service and pay off tens of thousands in loans? Yes, I can hear all you English and History majors grumble. But I know several English majors who upon graduation found work at Starbucks. In some cases, these already indebted (and unemployable) students go back to school once again for advanced studies in the hope of improving their employment prospects. I’m not trying to be mean here, just pointing out some honest facts. The problem I think is students are led to believe student debt is good, and therefore it’s OK to study any particular subject without considering if the investment in time and money makes long-term financial sense.
Another beef I have with student debt is it’s easy for students to get loans. So easy in fact many students take on loans before considering ways to avoid debt, such as part-time work and scholarships. I’m really not trying to be insensitive to students as I’ve been on both ends of the student debt issue. I graduated from my first degree with zero debt, and then graduated from my second degree with a whopping 17K in debt. I’ve written and reflected on how I avoided student debt in my first degree and then how I paid off my student debt in six months in my second degree. I must admit, graduating with no debt is the highly preferable option.
2. Mortgage Debt
Another form of perceived “good debt” is mortgage debt. I’ve really dreaded writing this part, mostly because I hate telling people their mortgaged homes are both money pits and terrible investments. I dread conversations where my friends proudly tell me about their 25+ year mortgage and how small their payments are today. They really love to dig in and declare themselves superior to my renting self. They seem to think they’re building huge equity. Not true I say.
The sad truth about buying a house is the actual cost far exceeds the simple sticker price of the home. It’s not hard to spend several times the purchase price of the house when considering all the costs. For example, a buyer of an average $325,000 detached house who takes out a conventional 25-year mortgage will pay for that house twice in interest alone. In the illustration below I show a $325,000 house, at 6.5 percent interest rate, over 25 years (with $2,194.42 in monthly payments) to cost in total a whopping $658,326.98. That’s $333,326.98 in interest alone! Don’t believe me? Try my Loan Amortization Calculator for yourself. Better sit down first.
Isn’t “good debt” fun? Now add 25 years of property taxes, home insurance, normal maintenance, and add a new roof just for kicks and the total cost of buying this house could escalate to a million bucks, easy.
Now I hear all the homeowners out there howling, “But my home is an investment, property values only go up!” Not true I say. A house is a very inefficient means of investing. For starters, consider your house as part of an investment portfolio and tell me what percentage of the portfolio it entails? I bet most people’s homes comprise 50-75 percent of their total portfolio. Now tell me, when invested in a single piece of real estate, how diversified are you? An investor with most of their eggs invested in one basket is not diversified and is very open to market risk.
For my investment portfolio I highly prefer stocks. After inflation, a diversified portfolio of stocks returns 7 percent a year over long periods. The bonus with stocks is I can easily diversify and buy various sectors, including: Financial, Communications, Energy, Health Care, and Real Estate. I actually own real estate in the form of Exchange Traded Funds (ETFs). OK, if the stock market returns 7 percent a year, your house must be making you a fortune right? Nope. The sad truth is houses barely keep up with inflation in the long term. Over at MSN, a fellow with alias SmartMoney does some serious number crunching to show the average real return for houses over long periods is zero. He says:
Houses don’t appreciate any faster than the level of inflation over the long term, so forget about buying a home and put your savings into stocks.
I highly recommend reading his article Why Rent? To Get Richer! before getting angry with me. Ohh, and there’s no guarantee when selling your house the price will be up. Just look at the current sub-prime meltdown, or the deflated home prices in the early 90s, and tell me how fun it is to sell your biggest single undiversified investment during a downswing?
My final point on this matter is addressing those who consider my rent as money thrown away. Fair enough. I pay $1000 a month in rent. Let’s look at my earlier example, the homeowner with a $325,000 mortgage with payments of $2,194.42 per month. Given the alternative, I’m perfectly happy to give my landlord $1000 a month and save the home owner’s otherwise spent mortgage payment of $1200. I take that $1200 and invest in a portfolio of diversified stocks which will return 7 percent over time. Additionally, I save all the “other” costs the homeowner pays, costs on property taxes, home insurance, normal maintenance etc. In reality, I save $2000 a month by renting and I earn a higher rate of return.
Need some more proof? Let me introduce you to Millionaire Mommy. She’s a millionaire who sold her home and now rents. Her thoughts on Rent Vs. Buy: The Hidden Cost of Lost Opportunity are stellar and really resonate with me. Another good read is Jersey Gilbert with Is Your House Really A Good Investment?
3. Business Debt
It is a dream for many people to quit their indentured job of servitude and go into business for themselves. Everyone says being your own boss is the road to riches and financial independence. Watching the news it seems pretty simple, just look at people like Martha Stewart and the Google guys who risked it all to become billionaires. All Martha did was perfect pie crust. And the Google Guys, well, they just search for stuff. Success can’t be that hard, right? Well, maybe. But the honest truth is I don’t think most people have the smarts or the financial acumen to run a profitable business. Most people can’t manage their own personal finances, they don’t have an emergency fund, have little retirement savings, and carry considerable credit card and consumer debt. Now honestly, how the heck can a person with little financial smarts run a profitable self-run business? I think it’s a shame really. I’ve seen a few good people with interesting business ideas go completely bankrupt because certain “experts” led them to believe business loans and debt are the preferable path to success and riches. I think the big-bad-banks sell business loans as the preferable “good debt” path since all debt is good business if you’re on the other end of interest collection.
Despite my negativity on business debt, I’m not opposed to people starting-up a company. There are ways of going into business without going into debt. In today’s internet age it takes only $9.99 to buy a Web domain name and another $100 or so a year to get the site hosted. One no longer needs office space and storefronts to run an operation. There are indeed ways to avoid business debt. Get smart about it! Ohh, perhaps learn to manage your personal finances before quitting your indentured day job. Learning some basic money management skills and having an emergency fund can go a long way when starting a fledgling business.
4. Health Debt
My final point regarding the “good debt” lie is my most important. How much is your health worth? How much is your relationship with your spouse worth? How does debt and the feeling it entails impact your mental, physical, and relationship health? I don’t know about you but when I had “good debt” in the form of student loans I felt like s$it. I felt stressed, tired, and suffocated by the weight of debt. I often had chest palpitations, and I felt as though I were drowning. I also felt tied-down to a job I hated with no freedom or choice. The debt had to go, and I had to work hard to pay the beast off. My relationship also suffered. At the time, my then boyfriend was free from debt and liberated to enjoy some disposable income by eating out and traveling. I hate to say it but I kinda resented his financial freedom. To make matters worse, I was exhausted from working over-time and my libido was dead. I may be female, but I really can’t get a hard-on for debt. It doesn’t turn me on, it doesn’t make me feel good, and it certainly doesn’t put me in the mood to get naked. Libidos aside, the issue was plain to see – my “good debt” was an obstacle and it made me physically sick and emotionally exhausted to deal with it.
5. Conclusions on Debt
I retired my “good debt” seven years ago. I feel great today having zero debt and a healthy diversified portfolio. I think being free financially is phenomenal both emotionally and physically. I certainly hope I’ve made you think differently about “good debt” and why I think it’s a lie. Cause really, how can anything termed “good” make one feel so bad?