- When it comes to taking on debt, always think about what it will give you in the end.
- Fund appreciating assets; don’t fund instantly consumed or depreciating goods.
- Credit cards are not evil if paid off in full. Loans for tuition, homes and businesses should help you build lifelong wealth if managed intelligently.
One of the big takeaways I got from Steven Covey’s 1989 best seller The 7 Habits of Highly Effective People is “Begin with the end in mind.” That’s an effective way to live your life, and it’s also a good way to look at debt—what will that give you in the end? That will help you determine whether a loan you’re considering is good debt or bad debt.
Good debt versus bad debt
Good debt relates to hard assets that appreciate over time. As the debt goes down, the assets appreciate in value. This could apply to home loans or school loans that help you increase your wealth (or earning power) if they can be paid off without undue burden in a reasonable period of time. Good debt can also apply to business loans if there is tax deductibility and the chance to grow your business dramatically in a way you couldn’t do on your own.
Bad debt applies to financing goods and services that you consume immediately—think food, clothing or loans on vehicles and other things that immediately depreciate in value. When it comes to student loans, the general rule of thumb is this: if the loan costs more money than you can pay off in 10 years—even with your increased earning power—then it’s not worth it. Likewise, vehicle loans are not necessarily bad if they help you free up cash flow. But do you really need a new vehicle right away? How about starting with a used vehicle or maybe just use Uber for transportation? At the end of the day, it’s just transportation, and you want to put your money into appreciating assets and minimize expenses for depreciating (or no-appreciation) assets.
Credit cards are not necessarily evil if you can pay them off in full every month. However, they’re a dangerous cash drain if you start accumulating credit card debt. The interest rates are very high, and typically the things you buy on the card are depreciating goods. You don’t want to be stuck with all debt and no assets.
Mortgages and business loans are generally used to purchase appreciating assets and to help you build your personal or business enterprise value. But you have to be brutally honest with yourself about your cash flow before taking them on. Again, minimize as much as you can on the bad debt side and take as much as you can on the good debt side to move your wealth forward. Wherever you happen to be in life, that’s generally a good rule of thumb.
Until next time, enjoy. —Gary