How to Tell the Difference Between Good and Bad Debt
Laura interviews Howard Dvorkin from Debt.com about the state of debt in the U.S., tips for consumers and small business owners, how to prioritize payments, and ways to understand the difference between good and bad debt so you can eliminate them faster.
Most Americans have a love-hate relationship with debt. We like using it to buy homes, buy cars, and pay for college. But we don’t like feeling strapped by debt payments that leave us unable to reach critical goals, such as saving for retirement.
According to the Federal Reserve, consumer debt was near $14 trillion after the second quarter in 2019, the twentieth consecutive quarter of debt increase in the U.S. That staggering number is the total of Americans’ home, auto, student loan, and credit card debts.
If you’re struggling with how to prioritize debt or make payments right now, you’re not alone. The key to digging out of debt is staying focused on wise solutions, not dwelling on problems.
One of the questions I often hear about getting out and staying out of debt has to do with setting priorities. Many people are confused about which debts to tackle first and whether it’s smart to eliminate all debt.
The best way to create a plan for getting out of debt is to understand the difference between good and bad debts.
The best way to create a plan for getting out of debt is to understand the difference between good and bad debts. Debt that allows you to make money or increase your net worth is good. But debt that causes you to lose money or net worth is terrible.
For example, an affordable home mortgage is generally a good debt because it allows you to buy a home that may appreciate. An auto loan is generally a bad debt (even though it may be necessary for most people) because vehicles depreciate quickly and rarely make money for the owner.
You get the idea. Going into debt for vacations, clothes, electronics, or furniture is not a wise investment in your future. Likewise, buying a home that’s out of your price range is never wise. A good debt must be affordable in the first place.
If you use debt to finance a lifestyle you can’t afford, or if you’re paying sky-high interest rates, it should be addressed sooner rather than later.
If you have debt, but also have plenty of savings and a steady income to cover it, it may never turn into a problem. But if you use debt to finance a lifestyle you can’t afford, or if you’re paying sky-high interest rates, it should be addressed sooner rather than later.
To get the perspective of a debt expert, I interviewed Howard Dvorkin. He’s a CPA, MBA, personal finance author, serial entrepreneur, and Chairman of Debt.com.
Howard has founded and served on numerous boards of directors, including the United Way, Better Business Bureau, American Heart Association, and Junior Achievement. He’s received many honors for his community leadership and philanthropic work in South Florida.
On the Money Girl podcast, Howard and I talk about the current state of American debt and how consumers who are in trouble can find help. We cover a variety of topics, including:
- The current debt environment in the U.S.
- How the COVID-19 crisis has changed the consumer debt landscape
- The difference between good and bad debts
- Tips for struggling consumers to pay bills and protect their finances
- When you should or shouldn’t consider declaring bankruptcy
- How to prioritize debt payments when you can’t make all of them
- Advice for using debt wisely when starting a small or side business
[Listen to the interview using the embedded audio player or on Apple Podcasts, SoundCloud, Stitcher, and Spotify]
Debt.com provided the following tips.
Tips for using debt wisely when starting a business
When you started your business, you probably obeyed the mandate, “It takes money to make money.” You either saved, raised, or borrowed enough to get your new company off the ground, and hopefully stayed aloft long enough for revenue to start rolling in.
But there’s a problem with the common expression that it takes money to make money—it doesn’t tell you what you should spend your money on and what you shouldn’t. Here are three questions every business owner should ask before financing a purchase.
1. Would the debt affect customer acquisition?
If you run a delivery service that pulls up in front of your customers, you may need to finance a new car or truck. In their driveway or on the highway, your vehicle is a moving billboard for your company. Customers aren’t likely to trust a rust-bucket with your logo on the side.
However, if your truck is roving from one warehouse to another, a reliable rust-bucket is just fine. The last thing you need when launching a new business is a monthly vehicle loan payment.
2. Would the debt improve your company or your ego?
Many new business owners finance brand-new office furniture and justify it as a customer-facing expense. If you invite customers to your office, are you trying to improve your business image or stroke your ego?
Are you trying to improve your business image or stroke your ego?
You could argue that new office furniture sends a negative message about a new business. As in, “Why should I hire this new and unproven company when it seems to waste money on new desks instead of investing in new equipment?”
The most tried-and-true sales pitch for a new company is three words: We are hungrier. Hungry means lean and focused. Buying quality used furnishings and vehicles, and keeping them nice and clean, sends that message to your customers.
3. Would the debt hurt your personal finances?
Many new business owners cobble together startup money from myriad sources. They save some, borrow some from friends and family, and take on more personal debt.
Using personal debt is the simplest but deadliest way to start or grow a business.
Using personal debt is the simplest but deadliest way to start or grow a business. It’s easy to borrow against your 401(k) or take out a home equity line of credit because you don’t need anyone’s permission. You don’t have to make a pitch or write a business plan.
While the loans against your 401(k) come with low-interest rates and are tax-exempt, the problem is that you’re borrowing from yourself and missing out on the growth you’d earn from keeping the money in the account.
As for a home equity line of credit (HELOC), they’re tempting because you can spend home equity on whatever you desire. But HELOCs are dangerous because you can lose your home if values plummet.
The bottom line is that you should plan your business debt carefully and consult experts. And If you have debt that’s grown out of control or that weighs you down psychologically, now’s the time to take swift action to repair the trouble.
About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
