Skill Level Intermediate
- Though we all know we're supposed to avoid going into debt, there are situations when debt actually makes financial sense. So-called good debt is a loan or other type of credit product where the asset that you're buying actually gains in value. Common examples of good debt are mortgages or student loans. Since most of us can't afford to buy a property for all cash, a mortgage allows us to purchase a place to live that will hopefully sell for more than we bought it for, creating wealth in the form of equity. A college education, even when financed with student loans, usually affords the borrower a chance to earn far more over the course of their career than they would have been able to with a high school diploma.
Of course, appreciation and increased earnings aren't guaranteed, so even good debt carries risk. Your house may actually depreciate, or you may struggle to find well-compensating work in your field. Here's how we can be smart about leveraging good debt to actually create more value in our lives. First, think long term about your financial values and circumstances. This is tough, because we can't always predict how these will shift over the years. But I've worked with so many people who decide that they don't actually like the profession for which they're trained, or they want to pursue something in the nonprofit field, start a business where they're not guaranteed a paycheck, or leave the workforce to be a stay-at-home parent.
It's painful to be stuck with a choice that you made years earlier, so think about these things before you make the financial commitment. Next, be your own expert on what you can afford. Mortgage brokers and financial aid officers should not be telling you how much debt to take on. Just because the formula says that you're approved for a certain amount doesn't mean that you should borrow that much. Finally, educate yourself on what you're buying. The Department of Ed has a number of online resources to help you research options for higher education, including a college score card where they compare schools by cost, graduation rate, and the average salary for graduates in different degree programs.
When it comes to buying a home, make sure you look at comparable property values, taxes, price per square foot, and trends in your housing market. It should go without saying, but it's critical that you understand everything about the terms under which you're borrowing. The fine print matters and it can matter for a long time. So make sure that you know what you're signing.