Taking debt is not usually a bad thing, how you use the money from the debt is what is really important.
Here are examples of “good” debt:
- Buying a personal residence that spends no more than 20% of monthly income on total housing costs. This includes a sizeable down payment (preferably no less than 20%, but I understand that can be hard to save for given the nation-wide cost of housing)
- Reliable transportation that is one or two classes below what you could presently afford to pay for (Again, this would include a sizeable down payment and the loan would be no more than 5 years, but preferably 3 years).
- Some types of business debt – utility here is the key – if you own a business and you need something to produce income, then using leverage to purchase an asset is not a bad thing. I would make sure you can afford a short amortization period as to pay off the note in as short of a time frame that you can.
Here are some examples of “bad” debt:
- Buying a personal residence putting nothing or 3% down on the property, in a neighborhood where you spend more than 30% of your income on housing only.
- Most types of consumer debt – given the extremely high interest rates, most credit card debt, mobile loans debt is bad debt. I would adopt the mantra of, “if can’t pay cash for a consumer item, I can’t afford it”
- Margin debt – many times brokerages will allow you to borrow money to purchase investments. This could hypothetically make some sense since you may be able to earn more than the interest you’re paying, but in my opinion, this is ALL bad debt. If you purchase any kind of security you’re at risk of losing the whole thing, while the margin loan isn’t going anywhere. This is bad bad bad debt.
Not all debt is bad and in fact is quite helpful as it allows you to enjoy the fruits of the labors of others while paying them back. What’s key is to always buy less than you can afford and when you do buy with debt, to put a lot down with shorter periods of amortization.
There is no stress quite like a crushing financial stress and buying less than you can afford will help you avoid many of the financial problems that plague our society today.