Good debt, bad debt and good bad debt

There has been an awful lot of noise in the media recently about the increasingly high levels of debt the average Canadian is carrying around on his or her back. And rightfully so: According to a recent report from Statistics Canada, our total national debt load, including mortgages, sits at around $1.8 trillion. (Why does that number always make me think of Mike Myers?). That’s more than $50,000 for every Canuck. But amid all the commotion are some surprisingly difficult-to-answer questions: Is all this debt bad? Is any of it good? And how can we determine what debt is good, what debt is bad or should we just try to avoid all debt like the plague? The answers aren’t always clear-cut. Clearly, further insight is required.

Economic types traditionally describe debt as being either good or bad, depending on what it’s used for. The good stuff is generally defined as money borrowed to buy something that will appreciate in value, like a house. Conversely, bad debt is described as money borrowed to buy something that will depreciate in value, like Buddy using his credit card to borrow $2,000 for a new set of golf clubs (they’re on sale!), because everyone knows you’ll play like Tiger Woods once you have a $2,000 set of his Nike golf clubs.

Unfortunately it’s not that simple. Not all good debt is good and not all bad debt is bad. (Warning: This is going to get wordy.) Yes, I am saying that there is such a thing as bad good debt and good bad debt. An example of bad good debt is when Buddy goes out and buys an oversized house that exceeds his needs. And to make matters worse, Buddy buys the house before he is financially ready. He puts down a too small down payment on his too big house and as a result, he ends up with a too big mortgage—which he amortizes over too many years. Given enough time, the house will likely appreciate, and this technically makes Buddy’s big mortgage “good” debt. However, it’s unlikely the house’s value will increase enough to cover the cost of the interest he’ll end up paying, let alone the larger expenses the house is going to generate: heating, upkeep, taxes and so on. To boot, there is a real possibility that this “good” debt will interfere with Buddy’s ability to properly save for his future. Broadly speaking, if Buddy’s housing costs (mortgage, utilities, insurance and taxes) exceeds 32% of his gross income, and if he will be paying those costs for more than 25 years, then it’s bad good debt.

On the other side, when Buddy’s sister Buddy-Lou takes out a two-year loan to help her pay for a gently used Honda Civic, that loan is technically bad debt since the car is going to depreciate. However, borrowing this money makes more sense than borrowing for a new car and it certainly makes more sense than leasing a new vehicle. (We’ll save that discussion for another time.) Assuming she takes care of it, Buddy-Lou’s car will still have value for years after the loan is paid off. Sure, it would be nice if she had the money in her bank account to buy that Civic when her old car died, but it would also be nice if George R. R. Martin didn’t kill off all of the best characters in Game of Thrones. Life happens. The loan needs to be manageable, without putting pressure on Buddy-Lou’s ability to save for her future. If that’s the case, it’s good bad debt.

It’s important to understand there is a big difference between accepting that you likely will incur some debt as you go through life and accepting debt as a way of life. It’s also a good idea to occasionally remind ourselves that even good good debt, like a properly structured mortgage is debt nonetheless and, as such, the interest you are paying on it isn’t doing you any favours. All debt, good, bad or anything in between, costs money and we should always be on the lookout for ways to pay it off as quickly as reasonably possible.

As a nation, we have become far too comfortable with personal debt. Today’s low interest rates are certainly a contributing factor, but the “keeping up with the Joneses” syndrome plays a part too. In some circles, it has become acceptable, even fashionable, to rack up mountains of high-interest credit card debt and then borrow more money to make the payments. Do not buy into this thinking. Pun intended. Credit card interest rates are anything but low, with many cards charging up to 29.99% interest. Even a “low interest” credit card will charge you around 12%. If you’re carrying a balance on your cards and you’re struggling to pay it down, you should transfer the balance to a low interest line of credit while you work it off. That would at least be better bad debt.

There is an inherent danger in describing debt as good. Sure, some types of debt are obviously better than others but that’s not the same thing as being good. Maybe we should further refine the two traditional definitions of debt into “bad debt” and “responsible-debt-that-I-thought-about-carefully-before-I-took-on-but-I-still-need-to-eliminate-as-quickly-as-reasonably-possible debt.” Because really, the only good debt is no debt at all.

Robert R. Brown is a personal finance speaker and the author of Wealthing Like Rabbits. Follow him on Twitter @wealthingrabbit