Bad Debt - Eliminate it and Keep Good Debt

Poor People Think Debt is Bad

There is a difference between good debt and bad debt.

There is a currently a wave of proponents for eliminating debt as the route to financial security. These proponents do not distinguish between good debt and bad debt. Unfortunately, I think this is the way poor people think - that all debt is bad.  Rich people do not think this way.

Rich people understand the difference between "bad debt" and "good debt."

By the way, I don't think that a "poor person" describes a person with little money. For me, a poor person is one who thinks in ways that makes them poor.  For example, have you seen the documentaries about those people who win the lottery and within a short time, are broke? These are poor people that temporarily have a lot of money.

Poor people do not like debt because when you are indebted, say on your home or car, you can lose the asset if you don't make your payments. These assets can be foreclosed on or repossessed. Additionally, if you have no debt, then those payments are eliminated and you have more cash.

Also, there may be people who think debt is bad because they use it inappropriately. They borrow money to buy consumables. This is bad debt. So they end up with debt payments to a credit card company (at interest rates that no rich person would ever pay) and the item they purchased they have already consumed. Debt to purchase something you consume is bad debt.

Last, poor people have bad debt because they overuse it. The use more debt than they can repay. They do not think about contingencies (what if I get sick? what if I lose my job? what if my car breaks down?). So when their income is interrupted and they cannot make payments on their bad debt, their assets are repossessed. Bad debt is a burden.

Now, let's consider good debt.

Rich People Like Good Debt,
Abhor Bad debt

Rich people think about this differently. Rich people do not use bad debt to buy consumables. They only use "good debt" to buy assets that endure (e.g. businesses, real estate, other investments). Additionally, they want debt because in many cases.  It's called using other people's money. Rich people can borrow money at say 1% and then invest it to get 4% (this is how banks make money). Poor people would also like to do this but they generally never accumulate much money because, well, they are poor people.>

Note that a poor person can become a rich person. It happens all the time.

You have read many accounts of people born in poverty that become rich successes.  The best example is the story of Chris Gardner portrayed by Will Smith in the movie "Pursuit of Happyness." Chris goes from homeless, eventually, to multi-millionaire.  But Chris was always a rich person because he thought like a rich person even when he lived in the subway bathroom.

Back to good debt vs bad debt. I like my house. I have debt on it. Had I not accepted debt to buy it, I could not have purchased it years ago. I did not have all that cash. So I live better because someone let me borrow money. The debt costs me about 3% and I can comfortably earn 8-10% on that money.

Where can you earn 8-10%? There are many ways but one way is that I lend money to poor people. I don't know if they are poor or rich but I lend money to people who have ruined their credit (i.e. they think like a poor person and have overused bad debt) and cannot get cheap money at the bank. These are people who got into financial trouble.

So I lend them money at 8-10% so they can keep their homes. They can pay me back any time so they are not forced to pay that rate. At any time they qualify, they can go to the bank and get the "rich person's rate" of 3%.

Another reason rich people like good debt is because most countries in the free world are democracies. This results in elected officials spending more money than the government gets in taxes. This causes inflation over time and the devaluation of the currency. In other words, $1 today only buys 90 cents worth of stuff three years later.

So when you have good debt, you pay off debt with money that has a lower and lower value over time (i.e. you borrow a dollar but when you pay back the dollar, it is only worth 90 cents or less). In other words, if a piece of property doubles in value over 10 years, the fixed debt (good debt) on that property has a lower value relative to the property than when the property was purchased. So use of good debt can and does make people very wealthy.

Good Debt Permits You to Live Prosperously

I have a business. It have debt on it. I was able to expand and grow my business by borrowing money. I comfortably make payments because what I earn on the money borrowed is more than I need to pay each month.

The respectful use of debt allows one to live better, have more things to enjoy and in general, live more prosperously. The lack of respect for debt (i.e. use of bad debt) and using it inappropriately can easily lead to poverty.

So should someone at the cusp of retirement try to pay off all of their debt? Not necessarily. If you can get an interest-only loan on your real estate (at today's unbelievable bargain rates) and invest that money for a higher and relatively secure return, debt makes sense and can give you a better life.

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