Good Debt Versus Bad Debt

After having to go out this past week and "invest" (more like "dump money into") a new-to-us vehicle, I've been thinking a lot about what is "good" debt and what is "bad" debt.

For starters, if you have more debt than you can afford, it's all bad. Tha't's pretty simple. If you can't afford it, you shouldn't be buying it.

However, if you have debt that makes you money (like your home generally does), that's good debt! Especially if you can afford your mortgage payments, and are making every effort to pay down early (and save yourself some interest dollars). Over the long term, your home will generally appreciate at least a couple of percentage points more than inflation -- so most of us won't lose on a home. And we're building equity at the same time.

Bad debt, on the other hand, just costs you up front and downstream. Your car is bad debt, because at the end of your car's life with you, you'll sell it for much less than you paid for it. It costs you when you buy it and it costs you when you sell it. It is a classic depreciating asset. So, if it's already going to cost you money, why would you want to buy it on credit? Do your best to buy any depreciating asset with cash. That way, the cost of the item is as low as you can get it, because you haven't paid interest costs on top of the price.

That's what we're doing with our car. We found a nice second-hand vehicle at a local dealer. (It's always best to buy second hand because someone else has already paid the biggest depreciation for you.) We don't have all the money in hand, so we are temporarily using our line of credit. However, my wife will get her yearly bonus next month, and it should be just enough to cover the amount that we didn't have currently in savings.

Now, if we can just avoid another big emergency purchase for awhile. Here's hoping the other car keeps running!

Michael

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