Financial pundits like to talk about “good” debts and “bad” debts.
They draw distinctions between debts that are supposed to be good for your financial health and those that are not.
Good debts are things like homeownership debt and student loan debt. Bad debts are things like carrying a credit card balance and car loans.
As you might imagine, I think this is a crock.
All debts are bets about the future.
Taking on debt is a bet that you can pay for something tomorrow, plus interest, that you can’t pay today.
If you’re wrong, bad things happen. You get sued by the credit card company. Or the bank forecloses on your house. Or you have to declare bankruptcy.
(Bankruptcy doesn’t even discharge your student loan debts, by the way, so in what sense are they “good”? Isn’t that much, much worse?)
The problem before the 2008 financial crisis was that everyone became convinced that mortgage debt was a riskless bet. After all, housing prices had never gone down nationwide in the history of tracking home price statistics.
Future Fed chairmen Ben Bernanke even famously declared on CNBC that he didn’t “buy the premise” that home prices could go down nationwide:
However, the clever statistic about nationwide home prices masked a few important points. Just because home prices are increasing on average does not mean homes in your particular neighborhood will. Even in the heyday of the housing bubble, there were homes that decreased in value or stayed flat.
Those homeowners lost the bet.
And millions more joined them after the financial crisis.
The homes that they bought ultimately weren’t worth what they paid in principal plus interest.
Yet, even after national homeowner debt exceeded equity for the first time since 1945, financial pundits continued to talk about “good” debts and “bad” debts as though that distinction had any meaning.
There is no difference. As a looming crisis in the student loan industry threatens to plunge the United States into yet another recession, the key question for you to keep in mind is this:
Would I purchase this with my own money today if I had to, or am I only buying it because someone is willing to give me a loan?
If it’s the latter, then I humbly suggest you rethink your purchase, whether it’s a home, a degree, a car, or just an iPad.
Image by Guillaume Paumier / Wikimedia Commons, CC-BY-3.0.