What Is Debt?

What is good and bad debt?

What is debt? It’s a surprisingly hard question to answer even though there is a very concise definition available in any dictionary.

Here’s one very short definition:

“A debt is an obligation owed by one party (the debtor) to a second party, the creditor.”

Wikipedia

Pretty simple, right?

Not necessarily. You see, I’ve talked to a lot of different people about their debt and in those conversations, I’ve heard many different perspectives on what debt is. As I’ve thought about these different opinions and personal experiences, I’ve begun to analyze the dual questions of “what is good debt?” and “what is bad debt?”

What Is Good Debt?

The phrase “good debt” is a common one, despite the fact that debt – at least by its dictionary definition – does not seem to have much gray area to it. Rather, when people talk about “good debt” they are usually referring to any kind of debt that helps someone get to a better position in life or to avoid some unbearable outcome.

To see what I mean by this, look at the three scenarios below and decide which of them you would consider to be “good debt”:

1. You are a Senior in high school who has been accepted to your dream school. You’re soon to be off to college! There’s only one problem: your dream school is expensive and your scholarships and financial aid won’t cover the full cost, which means you will need to take on $35,000 of student loan debt in order to attend for four years. You decide to accept the loans and get the college experience you’ve been hoping for, knowing that it will take you many years to pay off.

2. You are a recent college graduate ready to settle down with your young family – your spouse and two children. Seeing as how mortgage interest rates and housing prices are low, you decide to buy a home that you plan on living in for the foreseeable future. You know that this $300,000 mortgage will require monthly payments for the next 30 years or until you decide to sell the home. But you feel it is a good choice because of its positive effect on your family life, not to mention the house’s potential for appreciating in value.

3. You are a middle-aged parent hoping to become a grandparent soon. You have a sudden medical emergency that requires extensive medical care. Your health insurance does not fully cover it and and your savings are not enough to meet the substantial costs. You have little choice since the care is necessary to your wellbeing. Fortunately, your health recovers over time, but you are left with $20,000 in medical debt. There are no interest charges, but nonetheless it will take you years to pay off this debt.

Which of these would qualify as “good debt” in your book?

I imagine that most people would consider one or more of the cases above to be “good debt.” That’s certainly true for me. But perhaps the more important point is that the definition of “good debt” is flexible.

Some instances of debt are necessary and cannot be avoided (such as the medical debt described above). So does that mean “good debt” is synonymous with “necessary debt”? I think not. I think that “good debt” can encompass more than just the kind of debt which is inescapable. In my view, there are times when one can proactively use debt to invest in oneself (i.e. student loans) or to open doors for the future, and these can constitute good debt. Not to say that will always be the right decision, but it can be. More broadly, I think “good debt,” similar to beauty, is in the eye of the beholder.

But does this help us answer the question “what is debt?” First we must examine the opposite phrase: “bad debt.”

What Is Bad Debt?

Some would argue that all debt is bad debt. They would have some compelling points in their favor in making such an argument, too. But let’s look at a few more scenarios to see what might constitute “bad debt”:

1. You are a Senior in high school and your parents help you get your first credit card. Wanting to buy some new clothes that will help you fit in with your peers and gain respect, you use the credit card to upgrade your wardrobe with purchases that you otherwise could not have afforded. After a year of obtaining trendy new outfits, you have suddenly built up a credit card balance of $2,000.

2. You are a recent college graduate just beginning your career and are newly engaged to your fiance. You are set to be married in six months, but you haven’t yet worked long enough to save up money for a traditional wedding ceremony. You decide that since you plan on only having one wedding, you’d like it to be as you envisioned it and are therefore willing to put the costs on your credit card. You put $10,000 on your credit card to pay for the wedding.

3. You are a middle-aged parent who desires to buy a sleek luxury vehicle that you’ve always coveted. Despite not having the money to buy the car outright, you decide that you’ll buy the car with financing and make the monthly payments for the next five years. You now have a car loan equalling approximately $40,000.

Now, which of these scenarios would you consider to be “bad debt”?

Many of us could point out the flaws of taking on debt for the reasons listed above, and many of those points would be accurate. But if you believe, as I do, that the definition of “good debt” is flexible, then it stands to reason that the definition of “bad debt” must also have a bit of flexibility in it. After all, while we might think it unwise to commit to paying $40,000 of debt simply for a vehicle, there are no doubt several of our own decisions that would look unwise to others who were viewing our decisions from afar.

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The Bottom Line

Ultimately you get to decide for yourself what your definition is and how that affects your decision-making. That’s the nice thing about this particular question. However, since our mission at ReadyForZero is to help all kinds of people get out of debt, I have to add a few final conclusions.

First of all, we should all remember and take to heart that simple definition of debt. In case you’ve forgotten, here it is again:

“A debt is an obligation owed by one party (the debtor) to a second party, the creditor.”

– Wikipedia

That’s it. An obligation owed by one person to another. Since we’re talking about finances here, these debts are financial obligations and in some cases they’re owed to large institutions instead of individual people.

But the bottom line is that the definition rings true. Any type of debt, whether you consider it a “good debt” or a “bad debt” is still a debt. That doesn’t mean you should ever feel ashamed of it (we encourage people to let go of guilt and/or shame because they are unproductive emotions); it just means you should acknowledge the fact that debt, no matter its origin, is still an obligation to someone else and for your own peace of mind and the sake of your future finances, it’s worth focusing your attention on it until it is paid off.

If you want to pay off your debt quickly and easily, we recommend you sign up for ReadyForZero and use it on a regular basis to track your progress toward becoming debt free. We’ll help you make the best plan for paying off your debt and we’ll also help you stay motivated with our timely reminders and helpful information.

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  • Trevor Ricks

    I always thought debt was a pretty clear topic, but there are a lot of reasons for taking out debt that might change its meaning. Good post. You also say we shouldn’t feel shame or guilt for debt because those are unproductive. I agree those feelings do drag you down, but I think feeling bad for your debt can also lead to action to change.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Thanks, Trevor, I really appreciate your comment. And yes, it’s an interesting question about those negative emotions. From what I’ve read, humans respond better to positive motivation than negative motivation. But I wouldn’t be surprised if it depends somewhat on the individual and their mental makeup as well. You’re probably right that for some people feeling bad about it may lead to action!