Debt: Never Good. Just Bad, Worse or Toxic!
Have you ever been to a seminar and heard the phrase ‘good debt’? Perhaps debt that allows you to negatively gear? Or debt that allows you to buy an investment property where the return is greater than the cost of servicing, thereby allowing you to make money out of thin air? It’s certainly a persuading argument as it tickles our greed glands.
Make no mistakes – while debt might be temporarily necessary (or perhaps useful in the sense of a double-edged sword), it is only ever ‘good’ for the lender who records it on their balance sheet as an asset. It is a recorded as a liability for the borrower, and liabilities are never good, just bad, worse, or toxic.
What Is Debt?
Debt is an advance on your future earnings.
In other words, when you borrow, you are reaching into the future and grabbing hold of future salaries, dragging them back and spending them today.
The more debt you have, the more committed you are to have to work – not just to meeting living expenses, but to pay back the ‘earning’s advance’. You become caught in a debt-trap once you’ve borrowed so much that you need your job more than your job needs you. That’s a very risky and dangerous way to live!
Here’s an interesting calculation (note: no information is stored, other than the number of times the calculation is performed):
Your goal is straightforward: Aim for $0 debt. That way you won’t owe anything to anybody and you’ll enjoy a sense of freedom only a precious few experience.
Bad, Worse & Toxic Debt
As I’ve mentioned, debt is a liability, so by definition, it can’t ever be good. Instead, debt can either be:
- Bad: meaning the interest is tax deductible
- Worse: meaning the interest is not tax-deductible
- Toxic: any debt past its due date for repayment
Bad debt is most commonly used to buy investments and hence might be temporarily necessary (but never good!), provided it is used in a controlled manner. Think of a school science experiment where you are using a very strong, dangerous acid: you want to respect it and be properly protected because it can cause severe damage if misused!
Thinking of investment debt as bad shifts your thinking to using it temporarily, sparingly, and only ever on your terms.
Worse debt is used to pay for a lifestyle in excess of earnings. A great example of worse debt were ads the CBA ran some years ago that featured the catchphrase “Where did you get the money for that? Equity mate!” Here’s one of the ads:
The marketing premise is that if you don’t have cash you need to buy stuff you think you want, don’t worry, just borrow against your home equity. You’ll be happier if you live your life in perpetual debt. Huh? Say what? Being convinced that debt is good (i.e. Equity mate!) is investing double-speak; clever marketing by lenders to trap you into a lifetime of interest repayments
Branding debt as worse will hopefully help you to use it sparingly, or even better, avoid it all together.
Toxic debt is debt that you have lost control of. Left unattended, it can kill you financially (which is why it is called ‘toxic’).
Take a moment and split up your total debt into its sub-categories of:
When Should You Use Debt?
You should only ever use debt when you can satisfy these three rules:
When you understand it
Most people understand the basics of debt: you borrow, you pay (interest), you repay (principal). Yet quite often there are some tricks that can trip you up. For instance, most interest-free credit cards require that you pay off the whole balance by the specified date. Fail to do that and interest is backdated and payable for that period on the whole amount borrowed, not just the amount that is still outstanding. Beware anything that uses “frill marketing”, such as low or no interest, extra loyalty points etc.
When you can afford it
You should only ever use debt when you can afford it. Never, ever, ever use debt to pay debt (i.e. meet interest or principal payments), and avoid as much as possible using it for lifestyle assets (which should be purchased for cash).
When you can escape it
The term “debt-trap” exists for a reason. Debt’s embrace seems warm at first, but ultimately becomes suffocating if you can’t escape its clutches. If you have a plan for getting into debt, make sure you have a plan for getting out of debt too.
What are your thoughts about debt? Post a comment and let’s get a conversation started!
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I agree. I borrowed to start a small business some time ago which subsequently collapsed within the year leaving me under a debt agreement. I would have been better off just going onto Centerlink payments. As it is I am still on those anyway with a mountain of debt over me.
Those are excellent thoughts Steve. My wife and I have never been to conscious of what others think or attracted to living beyond our means, however more than 80% of our friends have debt dragging them out of bed every day to go to work for items that depreciate instantly after purchase and to service meaningless loans that are only for lifestyle. This living outside of their means has made it impossible for these ones to even purchase a home…….mind you we live in country victoria where you can pick a 3 bedroom up for between 200,000-300,000………it’s very sad. Great insights and very equipping, keep it up mate.
Debt is the scourge of the world. Buying now and paying back later. What a load of rubbish. We live in a world of instantaneous gratification where the population must have the latest and best of everything and have it NOW. What a generation of spoilt brats we have turned into and the people flogging their “must have” items are taking us all for what we are …. absolute fools🤕
Interesting thoughts Steve – as always.
In my view debt is not good or bad. For me personally it is just a means to leverage investment returns. I can turn an mediocre investment of say 7-8% into an attractive one. But at the same time debt also leverages risk of course. So use it with caution, only if you can comfortably afford to pay it back even if interest rates increase and only for investment or business, not lifestyle purposes…
I agree with Andre – Using negative gearing wisely allows a smart investor the opportunity to purchase property at a time that it is beneficial to buy at a discount well below the genuine median price.
The problem is that many “investors” are not calculating the ‘REAL’ risk factors before making the decision to purchase.
One of the big problems is calculating rental income as being 52 weeks a year instead of building in a vacancy rate of 12 weeks a year. Regardless of calculating your interest at a fixed interest rate – build-in a 2% interest increase.
If the deal still stacks up using negative gearing for the shortest time possible – then just maybe this coud be a deal worth considering.
Great article! Completely agree.
Hi Steve,
I love the simple yet profound points you make using imagery :-
e.g. “Think of debt like a school science experiment where you are using a very strong, dangerous acid: you want to respect it and be properly protected because it can cause severe damage if misused! Thinking of investment debt as bad shifts your thinking to using it temporarily, sparingly, and only ever on your terms.”
How true – we wouldn’t want it to become toxic !
Benny
In my opinion debt is bad. Taking debt to repay a dept is suffocating. Although accountancy in Singapore has lesser rules which are easy to understand but concepts of accounts still consider debt as bad.
Agree, great article. But I don’t think it helps to just label people as “stupid” (as in the comments) – people are simply very, very uneducated and also act on emotional drivers not rational ones.
I remember when I paid my mortgage down to almost zero, I felt very out of the loop at work – because I had nothing to say when the others all moaned about their debt! I felt I should go out and upgrade my home, so I could be part of the group! It took some rational persistence to resist the urge.
Also, the level of not understanding financials is astonishing – a middle aged couple I know who are reasonably intelligent, told me proudly they had replaced their slightly old car without going in to debt, just using cash. “Oh”, I said “you have paid off all your mortgage have you?” “No” they said – without realising that the cost of their new car was really all the money they could have put on the mortgage and all the interest they paid on all the extra years of a home mortgage.
Plus, numbers of people I knew bemoaned the fact that their negative geared property had created a problem for them by becoming a positively geared property!!!! Again, professional, skilled people who seemed to not have a grasp of the basics of what their investments were doing.
Plus, people I knew who used salary sacrificing to buy cars, pressured me to do likewise, it was great and I would save money – yet they couldn’t explain to me how it worked, and I figured keeping my old car for a decade or two might be cheaper – but there was no way I could convince them of that.
I really had no one to talk to in my immediate cohort at all who I could have an intelligent conversation about money. I felt frustrated and alone.
I agree with Andre .