Good Debt Vs Bad Debt

When I was in my early teens I saw this stereo I just had to have. It had all the pieces; dual cassette, 5 disk CD changer, FM/AM Tuner, a huge amplifier and two tower speakers with massive sub-woofers.

"Hey mom, I need that stereo"

"How much is it?"

"It's pretty cheap! ...for what you get anyway, only $800"

I'm guessing my mom got a good laugh out of that but she was a good sport and offered to co-sign on a loan so I could get it. I was stoked.

The Loan

I remember going to the bank ( a small credit union ) and getting the loan with my mother. I felt so grown up and mature. I don't recall my exact age or what the loan terms were but I'm sure I wasn't too worried about them.

The Joy

I purchased the stereo and was so excited I could hardly deal. It was a really long ride home and it took a while to get it all set up. I had to go to bed and then school the next day before getting to set it up (torture), but I finally did and I was beaming with pride. It played the sweetest music and it could really crank it up!

The Reality

After not too long the newness started to wear off and while I still really liked the stereo the payments were starting to feel less and less worth it. I don't really recall the loan payment amount or how I paid it but I remember it being painful. I remember thinking it was going to take me forever to pay it off and each time the payments came due I experienced some regret.  

Setting the Stage to Hate Debt

This event made me realize that it's not always that great to get that instant gratification when you have to pay for it for so long afterwards. Plus I started to realize that taking out a loan means you're paying interest to use somebody else's money and that just makes your stuff cost more.

I swore off loans and debt. I didn't want them. I thought only a fool would borrow money and pay interest. I was smarter than that. I would save my money and pay cash. I could be different.

Big Expenses

A few years pass and now I'm getting ready to move out on my own when I see this car. Not just any car, it had a powerful motor and plenty of seating for my friends and space for speakers. It was used but in really good shape. One problem though, it was 10 thousand dollars! Now I know that was a pretty good deal for the car, the year, and the shape it was in but I didn't have $10k and I was pretty sure I never would.

Maybe a car loan is an exception. I mean, who can save up enough to pay cash for a car? I got a loan (thanks again mom!) and got the car. I still felt the same way about debt but this loan was a little different. This car was useful and kept proving to be useful and I really enjoyed it. So then I thought: maybe loans aren't so horrible you just have to be careful.

Learning how to be careful with Debt

Some loans are obviously bad. Getting one at a check cashing place for an astronomical interest rate isn't something you want to do.

Getting a loan on a new car doesn't really feel bad, but your paying interest (gonna cost more in the long run) and the asset you're buying is going to go down in value quite quickly. This is a double whammy to your financial situation.

But what if you could by a used car, with a loan, and get a job delivering pizzas? What if you could by a piece of machinery and make a product you could sell? These purchases allow you to improve your financial situation.

Sure you might spend less on the car if you were able to pay cash and not have to pay interest but you'd have to wait until you had enough saved up. But during that time you'd loose out on the cash you'd be making if you did have the car. With interest possibly being $10-$20 a month you can see that it is worth it to spend that interest to be able to make much more.

Good Debt

The way I see it, good debt is debt that allows you to generate cash sooner than later. It's called leverage, and just like a lever can allow you to apply greater force to an object, you can use debt to leverage the amount of money an investment can make you.

Hold up

Even good debt has it's limitations. Being in debt brings risk. Now that you have a loan on that car you have to make money to make the payments or it will get taken back. If you spend more money and buy a bigger, fancier car you'll have a bigger payment and will have to do more work (or more valuable work) to pay for it.

Having too much debt is commonly referred to as being "over leveraged" and you want to be care not to get in that position. We'll save that for another time though since this post is getting quite long!

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