In some circles, there is the idea that all debt is bad, and that it should all be paid off as soon as possible. For some time, I felt that way, too. (There’s nothing wrong with feeling that way, either. You manage your money in a way that works for you.)
However, I started differentiating between different types of debt, and I decided that some debt isn’t really that bad. Like so much in personal finance, how view and deal with debt is individual, and it depends on circumstance. Here are some things to consider about debt:
What is the Debt Used For?
Debt can provide you with a certain amount of leverage that can move you forward with your finances. One example is an education. The rising cost of college means that many people can’t afford to pay for a college education outright. If you decide that you need a college education to meet your financial goals, student loans might make sense for you. You can use your student loans as leverage to get more value down the road in terms of your future earnings.
In some cases, business debt and mortgage debt can also provide you with the leverage you need to get ahead. Even a car loan can be helpful, if you need the transportation. It’s important to be careful in these situations, though. Just because you can use debt to gain an asset that will pay off big down the road doesn’t mean that you should overdo it. Buying a big house just because mortgage debt is “good” isn’t solid reasoning. Instead, you need to figure out what you will use the home for; it probably makes sense to purchase a more modest home (or car or education).
photo credit: Johan Rostwall
The flip side, of course, is consumer debt. Consumer debt used to buy items that are likely to lose value or be used up quickly rarely turns out well. That debt should be paid of quickly, and avoided in the future.
If you can use that debt to invest in a viable asset that will benefit you down the road — and make up for the cost — debt doesn’t have to be bad.
Could Your Money Be Put to Better Use Elsewhere?
Another consideration is what you could be doing with the money you use to pay down your debt. If you are paying down high interest consumer debt, there probably isn’t a better use for your cash. However, paying down low-interest debt isn’t always the best plan. After all, you might be able to get a better return by investing that money.
My investments routinely offer returns that beat what I’m paying on my student loans and on my mortgage. Over time, this is likely to be the case to an even greater degree. It makes more sense for me to invest my money than to pay down the student loans faster, or to pay off my mortgage early. Over time, I’ll earn more in interest than I would have saved by paying down debt.
On top of that, business debt, student loan debt, and mortgage debt all come with tax advantages. You can deduct the interest. While that doesn’t entirely make up for what you are paying, if you combine the tax benefit with the fact that you can get better returns elsewhere, it doesn’t always make sense to pay down your debt — especially if you used it to purchase an asset.
Before you decide that you move on from paying down your credit card debt to tackling your student loan debt next, consider your situation. Do you really need to put your money there? Or could it be better used growing your wealth over time?