Good Debt Myth

Debt is a controversial subject so let’s get into it.

When people talk about “good debt” they usually mean debt that creates value. In other words, it’s debt that will hopefully create wealth sometime in the future.

An example that’s often used is a student loan. The myth goes that by getting in debt to get an education, you are ensuring that in the future you’ll use that education to get a better job and thereby create wealth. This myth is coming to light since we’re in the middle of a student loan crisis where people have gone into massive debt to get their education and are still unable to find a job that pays enough to pay these loans off.

The same example of a mortgage is used because it’s often said that property values generally go up. Of course, after the crash in 2008 we know this isn’t always true. While it’s true that property values have steadily gone up since the crash (in some parts of the country), it’s also clear that another crash could always be around the corner. It’s irresponsible to claim that you can count on property values to generally go up, as we’ve seen.

Nonetheless, let’s assume the best case scenario plays out and property values will go up. In making this argument, taking a mortgage loan might allow you to break even. I still wouldn’t call this good debt, but rather, a necessity where you’re not totally getting screwed.

Here are some more examples of what’s generally considered good and bad debt.

So-called Good Debt
  • Student loan
  • Mortgage loan
  • Business loan
Bad Debt
  • Credit cards
  • Auto loan
  • Store credit card
  • Other customer debt

There is No Such Thing as Good Debt

I think we can agree that most people get into debt out of necessity. In other words, most people wouldn’t take a student loan if they had the money set aside to pay for school. Most people wouldn’t get an auto loan if they could pay for the car outright. And most people probably wouldn’t use credit cards if there weren’t any reward points and they had the money.

The main argument that debt proponents use is that debt should be used as a tool. In essence, the argument is that if you can take out a loan at a low interest rate, and use the cash you didn’t spend on the purchase to invest at a higher return, you’re mathematically making wiser choice.

This would be true if risk weren’t a factor, but it is, especially when the potential is there to make high returns. In other words, you’d have to be a very savvy investor to be reasonably certain you could outperform the loan interest rate. And most people simply are not savvy investors.

None of this matters to the average person though because the average person doesn’t even have enough cash on hand to make any significant investments.

Therefore, the “good debt” argument really only applies to rich people, that is, people who can play around with taking out loans and using other people’s money with no significant consequences. They are probably the people who started this “good debt” talk but it’s all hypothetical to the average person.

I’m not against using debt in some instances, but let’s stop calling some debt “good debt”. Debt is simply a necessity sometimes, and you deal with it.

In fact, I believe you should avoid it whenever you possibly can. But the fact of the matter is that most people can’t simply save up $200,000 or more to buy a house outright. It’s just not something the average person can do, so it necessitates getting a loan.

Best Case Scenario on a Mortgage Loan

For the average person, best case scenario, there is one exception where we could say that taking out a loan might allow you to break even. This is a mortgage loan. Let’s crunch some numbers to see how this plays out.

  • The median house price in the US is $188,900 according to The Huffington Post.
  • The average down payment on a house is 16% according to Yahoo.
  • The average rate for a 30 year mortgage in 2016 is about 3.85% according to Bankrate.

How Much The House Really Costs You

Using the numbers outlined above, let’s calculate how much this house is going to cost assuming it’s paid on time every month for the life of the loan (30 years).

Our down payment is 16% on a $188,900 house, so the total amount financed is $158,675. At a mortgage rate of 3.85% the total interest paid over the life of the loan is $109,122.33. That’s how much it costs a homebuyer to finance their home. Therefore, the total cost of the house is $298,022.33.

How Much Will the House Be Worth in 30 Years

It’s difficult to say for certain what the appreciation of any particular property will be because it varies widely year to year and location has a huge impact on it. However, using a national average let’s assume after 30 years the house appreciates an average of 4% per year.

After 30 years this would bring the home value to $612,677.79. Wow, sounds like a great investment, right? This number is deceiving in many ways. For one, lets assume that a 30 year old house is going to need lots of repairs to maintain its value. This isn’t the big thing though, because we left out inflation.

Adjusted for inflation, you would sell the house for about what you paid for it. In other words, adjusted for inflation, that house’s appreciation rate drops from 4% to 0.2%.

I wouldn’t call this good debt, but rather, buying a house. As you can see, you shouldn’t consider your home, especially a home with a mortgage, as an investment.

The Take Away

Like I said at the beginning of this article, I’m a big believer in keeping your debt obligations to a minimum. I think taking out a mortgage is fine, because in the long run you’re getting a house out of the deal and you probably won’t lose money.

Therefore, you should fix your credit score in order to get a mortgage loan. Start by removing any collections from your credit report. But after you have a mortgage, there is no need to use a lot of debt. In most cases it’s much more financially responsible to simply save up for purchases like cars and other big ticket items.

This topic is quite controversial. I’d love to hear your feedback in the comments section. Do you agree with me, disagree?