When Is There Such a Thing as Good Debt?

Debt education
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Most of the time, the word "debt" has negative connotations. Debt costs you money -- thanks to interest rates -- and therefore takes money away from financial goals like saving and investing. And the stress of carrying and repaying debt can take a serious toll on your health and relationships.

So could there ever be good debt? There's no hard-and-fast answer. That's because how you use debt has a big impact on whether or not you can consider it "good." And you can have too much of a "good" thing -- and that's when it can turn into bad debt.

Yes, you can use debt as a tool. Debt can provide leverage and create opportunities for you to improve your financial situation if you use it wisely. However, it's important to do a cost benefit analysis. Let's consider three types of debt: investing in a college education, buying a home or starting a business.

1. Are Student Loans Always Good Debt?

After working with tons of millennials across the country, I don't think that student loans are always good debt. I've seen quite a few people with high interest rates on private student loans, and I caution you against taking out private student loans for any reason.

I don't think that many people consider how long they'll be paying back their student loans when they take them out.

Another warning: I think that when your student loans cross six figures, you better be making at least six figures for a very long time if you want to pay those off. While I believe that an undergraduate college degree is a baseline for most jobs, I've seen too many people with student loan debt so high you'd think they went to law school when really it was from an undergraduate degree from a private liberal arts college.

I don't think that many people consider how long they'll be paying back their student loans when they take them out. You could be in debt for the next 30 years, and this will have a dramatic effect on the type of job you can take when you graduate. A student loan calculator will help estimate your monthly payments once you graduate.

Student loans aren't necessarily bad. If you take them out to obtain a high-paying job that you could have only secured with a college education and earn enough to make your student loan repayments manageable, your student loan debt was good debt. Here are a few rules of thumb:

  • Keep your total loans under your projected starting salary when you graduate. If you're able to do that, you should be able to pay them off with the standard 10-year plan.
  • Cut down on the loan amount. Get college credits while you're in high school, go to a community college for your first two years, stick to a state school and apply for scholarships.
  • Get a job to pay for your living expenses while you're in school so you don't take out loans for living expenses.
  • Stay away from private student loans because they don't offer the flexibility of federal loans.

2. How Much Should I Borrow for a Mortgage?

Owning a home used to be considered the American dream, and for many people it still is. Most people need to take out a mortgage for their purchase. If you think you'll be in the same area for several years and can put a 20 percent down payment on a home, a mortgage could be a good long-term investment. Interest rates on mortgages are historically very low, and owning a home can also provide tax benefits. The nice thing about a home is that it's an investment you can live in.

However, I've seen a lot of people who are house-poor. People get so caught up in the whirlwind of buying a home that they spent more than they planned without realizing how this would affect their lifestyle or how they'll pay the mortgage if an emergency came up. Here are a few rules of thumb:

  • Make a 20 percent down payment so you can avoid paying private mortgage insurance.
  • Don't use your entire savings account for a down payment. Homes are a hotbed for dipping into your emergency savings. There are far more unexpected expenses that come up than when you're living in an apartment.
  • Boost your credit score before you buy. Make sure you have a score above 700 so you can qualify for the best mortgage rates available. This will save you thousands of dollars in interest over the life of the loan.
  • If you think you might move in the next five years, you might want to rent so you don't have to move during a down market and possibly sell your home for a loss.
  • In figuring out your monthly housing costs, the principal and interest on the mortgage loom large. But don't forget property taxes, insurance, utilities, repairs, landscaping, snow removal and other factors. Make sure that your monthly housing expenses leave room for other expenses so that you're not house-poor.

3. What About Using a Loan to Start a New Business?

I believe that entrepreneurship is the new job security for Gen Y. Incurring debt to start a business can be good debt if the funds help you to build a sustainable livelihood that allows you to repay any money borrowed and improve your financial situation. Just be cautious of how much debt you're taking on. Here are a few rules of thumb:

  • Self-fund your business venture with savings first. (I launched my own financial planning company with less than $10,000).
  • The smaller the investment, the quicker you can make money. It's much easier to start a business with less than $1,000 than ever before. Things like freelance writing, Web design and consulting are easy-to-launch side-hustles that can become full-time gigs.
  • Do your research and get experience in the field before your launch. Some business opportunities require much bigger up-front investments, which may lead to a small business loan. However, before you start your own restaurant with $100,000 investment, know that the success rate of new restaurants is extremely low.

Debt Costs Money: Use it Wisely

Debt can be good, but only if it helps you leverage your assets to build wealth. Every good debt has the potential to turn bad, so do your research and due diligence. Remember, it costs money to borrow money so be mindful of the interest rate on your loans and pay extra to pay off your debt faster. The fewer monthly obligations you have, the more money you have to fund a lifestyle that you love.

Sophia Bera is a virtual financial planner for millennials and the founder of Gen Y Planning. She is location-independent but calls Minneapolis "home." Do you want to be better with your money than 90 percent of your friends? Sign up for the free Gen Y Planning newsletter.

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Good debt doesn't exist for most people.

August 03 2014 at 1:40 PM Report abuse +2 rate up rate down Reply

socialisteconomics is what is wrong with America.

August 02 2014 at 8:56 PM Report abuse +1 rate up rate down Reply

What surprises me is how people don't work the system of debt.. I told my wife to take on as much student loans as she wants. It doesn't matter because we will never pay them off..

In the words of John Keynes.. "If I owe you a pound, that is my problem. If I owe you a million pounds, then that is your problem."

When you aren't a douche that needs credit, then credit no longer matters. Credit doesn't really exist... Spending your whole life to please the invisible credit score is the very money you will need someday.

I see the same screen names on here from other stories, so I know you people have heard me explain it. Stay living with your parents or in an RV from age 18 to 25, and invest your money at the right time in the business cycle, and you will have a half million dollars after taxes to buy a home.... Or you schmucks can take out a 20 year loan and spend your prime years paying off twice what you paid for that house after all the interest, fees, mandatory insurance, PMI, etc.. If you aren't aged 18 to 25, then sell your crap now while the housing prices are up and move into an RV... Valerie is always talking about old people that can't afford to retire, which is total crap... Live in a $5000 RV, and that social security check/ IRA will suddenly be like living in the Ritz.

You always see old people living in RVs and going to Florida for the winter... With age comes wisdom. The very day my youngest child goes to college, I am moving into a cheap ass RV and parking it at Walmart or out in the country at night. Depending on whether or not the cops in my city, give me the business or not. Screw borrowing to pay for a house, and screw paying for housing altogether.. I feel like an idiot for ever paying property taxes or heating this giant home I live in. I would easily have well over $10 million dollars if I invested all my bill money instead of spending it on consumption.

August 02 2014 at 5:52 PM Report abuse -4 rate up rate down Reply
2 replies to socioeconomist1's comment

@ Socio --- Thanks for the insult, Bozo. So nice that you have already labeled yourself as an idiot. Saves me the trouble of having to do that. LOL

I see you are still trying to sell your pipe dream of living in an RV. Good luck with that. Every retail parking lot in the country (including Walmart) has signs posted that prohibit overnight parking for trucks, RV's, etc.

August 02 2014 at 7:07 PM Report abuse +5 rate up rate down Reply
Marvin Harrison

Not everyone aspires to live like crap. Some actually enjoy a house, yard, pool, etc.
The author is not quite right here. My first house was 15.5% interest (really), and happy to have it. My payments over the next 8 years almost equaled the profit I made when I sold it. If you buy the right property near the bottom of the market, you can make money today even if you pay 5.25% plus PMI. The operative words are "the right property". There are houses out there where the mortgage payment with tax and insurance is still less than rent. Research, research, research.

August 03 2014 at 12:49 AM Report abuse +1 rate up rate down Reply

Good Debt = the kind of loan GW Bush got to purchase the Texas Rangers with less than 1% interest.

Bad Debt = Every other note that average people can get.

August 02 2014 at 5:38 PM Report abuse -1 rate up rate down Reply
1 reply to socioeconomist1's comment
Tom Wilson

You only get the best credit when you have the collateral to justify it. You should have stayed in school.

August 02 2014 at 6:24 PM Report abuse -1 rate up rate down Reply

That's easy. When the courts, lawyers and credit companies come after you!

August 02 2014 at 11:02 AM Report abuse rate up rate down Reply

Recovery without job participation,all based in an unsustainable DEBT.Any thinking American that falls in that trap is a moron.Every single day,we manufacture less and less,and the Nation gets poorer and poorer like a 3 world banana republic....Is that our future?

August 02 2014 at 8:46 AM Report abuse -1 rate up rate down Reply
4 replies to thefacts22's comment

Let me tell you folks----stop this borrowing business---Take as many as AP classes while you are in high school and go to a community college (sometimes you can take co9llege courses while you are in high school) and try to pay as much as you can. Also find out the cost of the tuition in Canada, Europe, Asia, South America and Caribbean Universities.

Now let me get to good debt. (This is not possible now a days but it did happened in 1970s). Some students borrowed at 3% interest rate and deposited that money in Bank CDs at 7 and 8% rates. That was smart.

Hey consumers --stop borrow and spend

August 02 2014 at 8:17 AM Report abuse +2 rate up rate down Reply
1 reply to fakeconomics01's comment
Marvin Harrison

The first smart thing I have seen from you. I did that but only made about 3% on the spread.

August 03 2014 at 12:55 AM Report abuse -1 rate up rate down Reply