Ever wonder if there is such a thing as “Good Debt”? I mean aren’t we all striving to get out of debt, and isn’t all debt bad debt? In short, no.
There is real satisfaction — and some security — in being able to honestly say, “I don’t owe anybody anything.” But that’s not reality for most Americans. Some things — college education, cars, homes, business startups or expansion — are so costly that few are able to pay for them in one lump sum. And the tradition of borrowing dates back a long, long time.
Installment loans date back to antiquity; it’s reported that a contemporary of Julius Caesar named Crassus built homes in Rome and sold them on an installment plan. Originally launched in the U.S. to help farmers buy agricultural equipment, installment loans were made popular by the Singer Sewing Machine Co. in the 1850s. The company’s machines were expensive — $40, at a time when a farm worker’s average annual income was about $1,200 a year — and few could afford to buy one outright. Singer sold its machines for a dollar down and a dollar per month. The machines vastly increased the owner’s ability to make clothing for her family, making the machine a solid investment. The concept spread quickly and by 1924, about 75 percent of automobiles were purchased using installment loans. Since it looks like loans are here to stay, it’s important to try to have more “good” debt and less “bad” debt.
What Is Good Debt?
Good debt is money borrowed to buy something that’s likely to increase in value — like a home — or that will increase your ability to produce income or that will reduce expenses. For example, the aforementioned agricultural equipment helped farmers grow and deliver more food which, fluctuating crop prices notwithstanding, would be expected to help them earn them more income. A sewing machine reduced the time required to make a shirt from 14 hours to one hour; a woman with a sewing machine could keep her family in clothing and still help her husband milk the cows and bring in the crops.
Three More Contemporary Examples of Good Debt
While the events of the early 2000s reminded us that home prices can go down as well as up, over the past 30 years homes have appreciated about 6.5 percent annually. Buying a home using a mortgage — assuming that you have reserve cash to cover payments should you lose your job and get good value for your money — is generally considered good debt. Compared to the costs of renting, which builds no value, the increase in equity in your home over time and the ability to deduct home mortgage interest from your taxes makes buying a home a decision that can save you money and help you build wealth.
Education — whether a two- or four-year college degree, technical college or advanced study — is a powerful way to increase your earning ability. While the $1 trillion of student debt owed by Americans is an urgent national concern, workers with a bachelor’s degree earn 98 percent more per hour worked — nearly double — compared to what their peers without a degree earn.
If you own a business, taking out a business loan to pay for an expansion that will clearly increase your net income is good debt. You’re investing in higher future earnings. Taking a lease on a sports sedan to use as a company car probably doesn’t fall into that category unless it will somehow increase your income in a way that a less expensive vehicle could not.
Remember that “good” debts can have potential pitfalls too. Home values in your neighborhood could fall for a variety of reasons while your taxes, insurance and maintenance costs remain — and may even increase. A four-year college degree is statistically a good bet, but in reality, having a degree in a field with low demand or low wages could make a student loan a milestone with few redeeming benefits. Borrowing to start a businesses can be risky: Eight out of 10 new businesses fail within 18 months of launch. You might want to hold off taking on big debts until you’ve proved the business is sustainable, then borrow to expand. Even if you are taking on good debt, making biweekly loan payments can significantly lower the amount of interest you end up paying and help get you out of debt more quickly. APP offers a lifetime membership that allows you to enroll an unlimited amount of loans. Use our loan savings calculator to see what paying half your monthly loan payment every two weeks can do for your bottom line.