Imagine a fresh start. You don’t have a single penny to your name. You’re in a new city and you don’t know anyone at all. You don’t have a job. What would you do? One option would be to live out in the streets. However, having a dirty appearance and wretched smell might hurt your job search. No. That wouldn’t work. You find yourself wandering door to door scouring for a job. A couple a days go by without any luck. On the third day, someone catches your eye, and they make you an offer. They will give you a place to stay while you search for a job. The only catch is that they want you to pay them back once you have stable income. Would you take the offer?
If you said yes, you just entered into debt. Good debt. You see, debt allows you to do things that you would otherwise not be able to. In this situation you have access to a place to sleep and bathe yourself. This debt allows you to stay well rested and clean while you look for a job. You have a much better chance of landing a job if you are rested and clean. This is precisely why this type of debt is good. Good debt creates opportunities, helps you reach your goals, and enhances your life.
Good debt will allow you to invest. You can invest in yourself or in the form of an appreciating assets. Some examples of good debt are mortgages, student loans, and business loan.
Most people do not have the capital to pay for a house without any loans. Good debt in the form of a mortgage will make your dream of purchasing a house a reality. I know of one expert who will argue that mortgages are bad. The recent housing crisis appears to have validated this argument. Despite these arguments, mortgages are not evil. Mortgages allow you to build equity in an asset.
When you rent an apartment or a house you are throwing money in the garbage. You don’t build any equity. Instead, you are building the equity of your landlord. Your rent goes towards their mortgage payments. Your landlord will reap the benefits of owning a home and what do you have to show at the end of your lease? Your security deposit…if you’re lucky.
A mortgage is only good debt if you are smart about it. People were not smart during the housing boom and collapse. People took out huge mortgages which they could not afford, and as a result, they went bankrupt and lost everything. These people did not know what they were getting into. They believed they could purchase a house worth half a million dollars while they only made $40,000 a year. The take home message is clear: only buy something you can afford. Your mortgage payments should amount to about 25% or less of your yearly income. Also, don’t forget about the other expenses associated with owning a home. Insurance, property taxes, maintenance expenses, and if applicable, homeowners association fees will all eat away your income if you don’t do your research beforehand.
Let’s face it, school is expensive. Without student loans I would have never been able to finish college. Many other people were in the same boat as me. Student loans gave us the ability to go to college and invest in something we otherwise could not have invested in.
If you do decide to take out student loans it is very important that you weigh your career options vs. the cost of going to school. The fact is, some majors are better than others in terms of preparing you for a career. English, Philosophy, and History majors are all areas that are not very specialized and could be difficult for you to get a job in. If you take out student loans to pursue a major in these areas you could have a very difficult time finding employment. You are better off pursuing something specialized such as Engineering, Accounting, or Computer Science. These areas of study give you skills that are highly sought after by employers and will get you a high paying job soon after college is over.
I’m not advocating against studying the arts. The issue is this: When you take out student loans to pursue something you love you are putting yourself at risk very early on in life. If the subject area you love doesn’t have job opportunities, you could end up with $30,000 in student loan debt while working for $10 an hour at a department store. This will put you in a deep hole very early in life that can be difficult to climb out of.
With that being said, DO NOT make student loans your primary source of money to pay for your education. Do your research and figure out other means to fund your education. One of the biggest regrets I have is that I didn’t take more time searching for scholarships before I started school. I know many people who have actually funded their entire education through scholarships and got out of school debt free. Besides scholarships, there are also many grants out there for students who need financial assistance. The amount you get awarded for these grants to vary significantly depending on your parent’s income status. You could also help fund part of your college by taking on summer jobs or working while you are in school if you can do so. You could also take extra classes over summer and graduate school earlier so that you begin working in your career sooner and take out less loans. Finally, if you or someone you know is in high school, I highly recommend doing dual enrollment or advanced placement classes. The beauty of these classes is that you receive college credits and don’t have to pay anything out of pocket for them!
Student loans can be a great tool to assist you in completing college. Just like I noted with mortgages above, you have to be smart about student loans. Consider what you want to study, where you want to study, and other payment options before making the decision to take out your student loans.
Businesses can expand at a much quicker rate when they use loans for leverage. Leverage allows you to use a combination of your money and someone else’s money and multiply the return on investment. Let’s take a look at one very simple example of leverage. Let’s say you have $5,000 and you invest it in your business and you have the potential to triple your returns. You could potentially earn make $15,000 on your $5,000 investment. Let assume you can do the same thing, except this time you take out a $10,000 loan in the process? Add your $5,000 to that and you now have $15,000 to invest. If your returns triple on that investment you could make up to $45,000. In both situations you only put down $5,000 of your own money. In situation one above, you made three times what you put in. In situation two, after you paying back the $10,000 you borrowed, you will make seven times what you put in. This is leverage in its simplest form.
Small and large businesses alike use leverage. In order to properly use business loans, consider the following: Will a loan help me expand business? Will a loan be used for investments only and not to cover ordinary business expenses? Do you understand the risk you are taking by leveraging debt? Have you minimized your risk of loss by doing adequate research? If you answered yes to all of these questions, you may be a good candidate for taking out business loans.
Remember, good debt is good because it will allow you to invest. You can take on opportunities. Good debt can turn bad. Just know one thing. Good debt does not close doors, it opens them.
Do you have any good debt? Have you ever had good debt turn into bad debt?