Radio talk show host and author, Dave Ramsey, is the latest media personality to be considered controversial. Why? Because he advises people to live without debts, no credit cards, pay cash for cars, furniture, and if possible, your home, and use the money that normally would go toward interest for savings and investments. This makes perfect sense, right? However, the proponents of “good” debt have attacked Mr. Ramsey's philosophy repeatedly.
“Good” debts are those that are collateralized, that is, that acquire a tangible asset that has the potential to appreciate, or those that allow the individual to increase their earning capacity. “Good debt” includes mortgages, student loans, or business loans. On the surface, these debts do seem reasonable. After all, the person who takes out a student loan should be able to earn substantially more money over the course of his or her lifetime than someone who has limited educational achievements. Putting money into a solid piece of real estate allows an individual to build wealth over time, whereas renting builds wealth for the landlord. In the eyes of some, “good” debt ultimately serves to enrich the debtor.
A second justification for “good” debt is that it frees up current cash flow to use for other things, such as investments. If a debtor pays only ¼ of his or her current income for a home, then there should be disposable income available to invest regularly in mutual funds, stocks, or to sock away in CDs or a money market fund. Laying out a large chunk of money in order to buy a car, a home or other big-ticket asset takes away investment opportunities, as the purchaser uses income to reimburse him or herself, rather than moving that income to growth opportunities.
In theory, “good” debt seems to win out. However, in practice, “good” debt doesn't look so good.
The reality of today's consumer is that overall, they maintain a negative savings rate of about 3%. In other words, good debt or bad, people spend more than they take in. This situation leads to a host of complications if major life changes take place that interrupt current cash flow. A job loss, for example, can throw the average debtor into a downward spiral that in many cases paves the way to bankruptcy. A divorce not only disrupts individuals on an emotional level, but the equal distribution of debt creates its own war zone between the two parties. Health problems create financial earthquakes on two levels, spending increases and income decreases. People with debt feel the squeeze on both sides, ending up in an emotional vice, the pressure of which leads to many bad decisions based more on desperation than on information. In these situations, no debt is good debt.
Another factor in judging whether good debt is all that good is the concept of freedom. During this election year, one political party took a poll that asked, among other questions, “Have you ever stayed at a job you didn't like because it offered health insurance?” Let's ask that same question with regard to debt: have you ever stayed at a job you didn't like because you:
- Had a house payment you had to make each month?
- Had a car payment?
- You needed to pay off student loans?
If the answer to any of these was “yes,” then debt has limited your choices and shackled you to your employment situation. No matter how “good” the debt may be (or may have been, in the case of student loans), the outcome is a lack of freedom. Alternately, would you have the option of leaving a job that was toxic, unfulfilling, or just plain not a good fit if you have a home that is free and clear, a car that was fully paid off and Sallie Mae wasn't send love letters each month? The answer here is a resounding “yes.” Even if the new job (or career or business venture) paid less that you were making during the first few years, you could easily afford the change because you have no debts to pay. For many of us who “recareered” at age 40 and did so without Donald Trump's salary, that still allowed us a pretty good life.
Does this mean that you should never take out a loan? Not at all, just don't let that loan remain a close and faithful companion. Do without some of the “goodies” early on, make the extra effort to pay it off early, use the additional cash available to increase the amount you put away in savings and investments, and learn that having your home, car, boat and education and your freedom, too is a great way to do life.
