I recently bought a pack of 64 crayons for my daughter. I had no idea there were so many colors. Back in my day, the world of colors consisted only of a handful of primary colors. But with the help of Crayola, my eyes have been opened to a new world of color.
It actually can be quite overwhelming deciding if you want to color Barbie in brick red, red violet, wild strawberry, or plain old red. This unsuspecting dad once had the audacity to call a crayon purple when in fact it was orchid colored.
However, Crayola taught me a very important lesson about debt. Debt discussions are very polemic so we tend to deal with debt in absolutes.
Is Your Debt Good Debt or Bad Debt?
Good Debt
To help us make decisions about debt, financial know-it-alls have created two categories for debt. A debt can either be good or bad.
Items usually listed in the good debt category include:
- House Mortgage
- Student Loan
- Car Loan – This one is sometimes placed on the bad loan list, depending on who’s talking. Personally, I think car loans are closer to bad debt than good debt.
What makes a good debt a good one?
A good loan is typically considered good because the item increases in value, is reasonable to your income, and it has a reasonable interest rate.
Bad Debts
Loans that are usually listed on the bad debt list include:
- Credit card debt
- Loans from cash advance agencies
- Unsecured personal loans
A bad debts are ones where your payments are too high in relation to your income, you have a high interest rate, and the item you purchased is decreasing in value.
The Problem with the Good Debt Vs. Bad Debt Discussion
The reality is that these categories don’t exist. They are simply something we created so we have a way to categorize our debts. However, if we were to add more options to the list and view the discussion as a spectrum from good to bad, we might make better choices. The discussion is healthier when moved from good and bad (black and white) to include a spectrum of colors.
What if, on the one end of the spectrum, was outright cash ownership with no interest and no payments. On the other end of the spectrum is a debt with exorbitant interest rates and the value of the item is decreasing.
Terrible debt ———->———->————->————–>———– Cash ownership
Now we’ve created a scale instead of just two categories. Now, instead of just red, there is brick red, red violet, wild strawberry, or plain old red.
I think we would all be well served to write a line across a piece of paper and on the far right write cash ownership. Then put all your loans where they fall on the list. Include a house loan, student loan, car loan, credit card debt, loans from cash advance agencies, and unsecured personal loans on that line. The only truly good thing would be the debt that you place all the way to the right – cash ownership. True, having a home loan is not a bad debt. But, compared to cash ownership, owning a home is better. That’s why paying off your mortgage early can be a good thing. This can also help us make informed decisions regarding Christian lending. The more lending is further removed from a terrible debt, the more ethical it becomes.
Some people get comfortable with certain debts because they are called good debts. However, if we compare our debts not to other debt, but to the possibility of owning it for cash, it no longer seems like a good debt.
Once you’ve created this list, you now have some direction for your debt repayment strategy. The goal is to move everything in the direction of cash ownership. Simply start with whatever is your worst debt. Put that debt at the top of your debt snowball spreadsheet. Then pay whatever is the little bit less worse debt. Work your way up the line until you’ve paid off everything that is worse than cash ownership.
Do you think people get comfortable with certain debts because we call them good? Do you think comparing everything to cash ownership (instead of other debts) might motivate people to pay off their debts?
{ 9 comments… read them below or add one }
Craig, I think it is really cool that you are coloring Barbies with your daughter! That is a huge message to the rest of us.
Your point about the debt spectrum is excellent. The Bible really says that all debt is bad and that debt is a sign of poverty and slavery. Ouch. With that as the measure some of the nicest homes have the poorest people living in them. It can really boggle the mind and our common ways of doing things. Because of the society we live in we have grown to accept and feel comfortable with the compromises we have had to make to have food, clothing, and shelter. I totally agree that there is a spectrum of hue and we need to continually need to prayerfully consider all our financial decisions.
When it comes to debt, I think it’s only the financial gurus who get caught up in good debt vs. bad debt. The wording does not make a difference when accruing it, because they usually just say the average American household has $8,000 worth of credit card debt. There’s no mention of bad debt.
I think the positive spin to encourage people to payoff debt is to promote being debt free! This eliminates both the good and the bad debt. Best of all, it promotes more financial freedom.
Craig, yes, I do think people tend to get comfortable with categorizing debts in this way. I agree with Carol’s comments. The Bible didn’t provide categories of good debt or bad debt. I have a home mortgage, but I still fill that I’m in servitude to my lender. I’m not saying don’t buy a house, but we should definitely be moving towards the cash end of the spectrum, as you said. In regards to home ownership we can do this sooner buy putting more money down when purchasing, or working hard to get to the point of paying extra on our mortgage.
I was initially dismissive of this article as I actually do believe that putting your debts into a good/bad arrangement makes sense and helps you focus and prioritize your efforts.
However …
… I should not have been as dismissive as I initially was as your “debt rainbow” (hope you don’t mind but the crayon color’s inspired me!) is a really good idea and I cannot argue with your concept of a Cash Ownership option at one extreme. You are 100% right that ownership is significantly more satisfying than debt regardless of the type of debt it is!
Thanks for adding one other tool to my toolbox for debt management!!
I must be color blind because I just see varying shades of grey.
My motivation was hearing success stories of living debt free and believing that I could do it too.
My 2 cents worth, instead of bad vs good we should be talking risk. What are the true risks vs marketing and scamming schemes that are out there. Bad and good are relative terms to folks.
I am in general agreement if your perspective. a few extra comments:
1) Another reason why home mortgages (including HELOCs) and student loans are considered good debt is due to their tax-deductibility thereby further decreasing their EFFECTIVE interest rate on you.
2) If one is a true believer in the theories of investment that, over long periods of time, the market will go up and give you the best return on your money to beat inflation, an argument can be made that leveraging a low-interest mortgage and investing your money in the market via a low-cost diversified portfolio will ultimately make you wealthier in the end. the counter-argument is the risk involved in case one loses their job, health, etc. and thus losing their house. but there are many people who would even go so far (eg. Ric Edelman, etc.) to say you can always have a mortgage (assuming low fixed rate) especially if it is tax deductible to you and you have a LONG (>20 yr) time horizon.
Thank you. Your post could not have come at a better time. We have almost always purchased our (used) cars with cash. (We took a loan out once as a car was a necessity where we lived). We are looking forward to some hefty medical expenses and it’s been suggested we draw out our current car savings and take a loan out for our future car. (Like everyone else.) We have another option which, in light of your post, seems more Biblical.
Another thought. Could the terms good and bad debt actually be coined by the banks? Good meaning they can foreclose and take all your equity if you miss a couple payments and bad meaning unsecured and they have to track us down.
I don’t believe in good and bad categories.Suppose a man is earning well, and has taken a car loan or spent a lot using his credit card, as he is sure, he can repay the amount. Suddenly, he becomes the victim of financial crisis due to loss in business, or any other reason, then no debt will be good for him. he will have to go for debt settlement.