Do you believe that there is such a thing as good debt? A lot of people believe this to be true. In fact, there are experts who tell us that there is such a thing. Debt can be good for your finances if you know how to identify one.
According to the data released on PEWTrusts.org, 8 out of 10 Americans are currently in debt. However, the data showed that the most frequent debt that is owed are home loans – which is considered to be a good kind of debt. This is considered good because it helps people increase their personal net worth. Although you start by being in debt, the more you pay towards the mortgage, the more equity you build for yourself. Equity is basically the value of the home that you own – because you paid for it already. The growing equity increases your personal net worth. In essence, that is what makes mortgages a good debt.
While this is true, do you really think that it is right for us to put ourselves through debt in order to increase our financial wealth? Is it necessary to be in debt just to set the motions that will lead towards our financial growth?
It is a difficult concept to grasp, after seeing how much grief debt cost a lot of Americans during the Great Recession. If you think that people would learn their lesson by staying away from debt, you are mistaken. Consumers continued to borrow money because of this thing called “good debt.”
Is there really a debt that will do us good?
According to an article published on USNews.com, good and bad debt is just a myth. There is no such thing. There is only debt. This is specifically mentioned by David Bach, the author of the book “Finish Rich.” He said that when it comes to debt, there is only better debt or worse debt.
Here are a couple truths that we know about debt.
Debt will always lead you to waste your money.
In a way, the author probably has a point. Debt cannot be good because you are wasting your money by paying off the interest of that loan. Instead of saving that money or better yet, investing it, you are making your creditor or lender rich. So it is really difficult to perceive something as good if you know that it will make you waste what little financial resources you already have.
Society wants us to be in debt.
If you do not believe this, then why do you think there is so much importance placed on credit scores? When you have a bad credit score, it is usually frowned upon in the financial industry. The negative effects of a bad credit score goes beyond being given a high-interest rate on future loans you will apply for. Utility companies may ask you for a deposit before providing their service. Landlords can deny you access to their unit for rent. Even employers may look differently at you when they find out your credit reputation leaves a lot to be desired. This is why people are usually encouraged to be in debt at some point.
Debt causes stress.
Another truth that you need to know about credit is that it causes us money stress. This is one of the reasons why it is hard to believe that there is such a thing as good debt. When you are in debt, even if it is considered a good one, it will cause you to feel stressed. You know that you need to work hard because you need to meet those payments. Take for instance home loans. This is considered to be a good type of debt. But even if you know that every payment increases your equity, the long payment term and the high amount associated with this type of loan can be daunting. If something threatens your source of income, it can become stressful because you know that you have this loan obligation to fulfill each month.
It is a sad reality that people are forced to be in debt because they feel and know that it is sometimes the only way they can jumpstart their plans to improve their finances. Sure a handful of people are testifying that they do not use credit and they are fine with the consequences of that choice. But the majority of consumers cannot make the sacrifices necessary to stay away from debt – even if it is a good debt.
Borrowing rules if you want to keep your debt from turning bad
Did you know that the average American is actually in a worse debt situation than Greece? According to an article published on Fortune.com, the debt-to-income ratio of Greece is 177%. Do you know how the average American compares? They have a whopping 370% debt-to-income ratio! Americans have an average debt of $204,992 – a combination of mortgage, credit cards and student loans. The median income of every household in the country is currently at $55,192. That puts us at a very huge disadvantage. If you are not careful with your borrowing habits, you could be one mistake away from a financial crisis.
But even if you decide to continue being in debt, that is okay. Being in debt will not guarantee that you will eventually ruin your finances. The key to keep debt from ruining your life is to be wise about credit.
It all boils down to your financial habits. If you do not react or respond well to debt, then you will get into trouble. Thankfully, there are a couple of tips that you can follow in order to ensure that you will only owe “good debt.” When we say good, we mean the debt that will be instrumental to improving your financial position.
There are 4 simple borrowing rules that you need to implement to ensure that you are being wise about debt.
- Borrowing when there is no other way. Some people may not agree to this and would counter that you should save for an emergency instead. We agree to that. But the point here is that you need to exhaust all other options before you decide to borrow money to get yourself out of a tight situation. Do not make it your first solution when you run into a problem.
- Borrowing to put money in your pocket. Another rule that you need to follow is to borrow money if it will put more into your pocket. For instance, applying for a home loan that you can rent out is one way to put money in your pocket. If you price the rent correctly, you can use the money paid by your tenant to pay for your monthly amortization and still have extra to increase your cash flow.
- Borrowing lower than your payment capabilities. The lender or creditor will always look at your ability to pay before granting you a loan. However, it is important that you set your own rules too. It is not enough that you borrow within your payment capabilities. You need to borrow lower than your payment capabilities. Just because you are allowed a $500,000 loan, that does not mean you should get everything. Be wise about the amount that you will borrow so all your extra money will not be tied to your loan payments. Leave some for your savings and emergency expenses.
- Borrowing with a plan. Lastly, you should always borrow with a plan. This is actually how you can keep your good debt from turning bad. Make sure you have a sound plan before you borrow money. This does not only involve a plan of paying off your loan. You need to have a plan about how you will adjust your budget to accommodate this loan. You need to have a plan that will let you know what to do in case your primary source of income fails you.
Try to follow these rules if you want to borrow money wisely. Here is a video featuring Robert Kiyosaki and other financial experts as they describe how eliminating debt is ridiculous. They all believe that there is such a thing as good debt. In this video, they mention that debt is not the problem. The problem that people have that leads them to financial disasters is lack of financial education. Watch the video to learn more.
