There’s No Such Thing as Bad Debt

Posted by Madison on September 13, 2010

I can’t remember how many times I’ve heard people classify debts as good debt and bad debt. And the definition is based on what the debt is for.

For example, mortgages and student loans are classified as good debt, and auto loans and credit card debt are often classified as bad debt.

I don’t agree. Classifying a debt based on the underlying asset makes no sense mathematically.

Expensive Debt vs Cheap Debt

Let’s look at it from a different angle. Right now, I like to focus on obtaining cheap debt at 3% or under. And some of the best places to get cheap debt are from 0% balance transfer credit cards and auto loans.

You can get a 2.99% auto loan at Penfed right now. And you don’t have to use it for a new vehicle, you can use it to refinance your current auto loan, use it to replace other higher interest rate debts, or even turn around and invest it in the 5% Certificates at Pentagon Federal.

Why on earth would we classify these as bad debts when they are cheaper than the good debts right now?

There’s really no such thing as a bad debt. The worthiness of debt should be assigned based on the price of the debt: cheap or expensive.

Leveraging Debt

Debt is nothing more than a tool to use for leverage. As a society, we have way too much emotional attachment to debt.

I’ve mentioned in the past that we used Creative Debt Reduction Strategies to do things like using a 4% student loan to pay for part of our mortgage (which has since dropped to 3%), and used credit card balance transfers at 2.99% to finance a rental.

Now, before you tell me I’m crazy, you know I’m not going to advocate taking on debt to finance lavish trips or buy the latest gadgets. The debt I’m referring to is strictly used for the following:

  • Financing a house you would purchase anyways.
  • Refinancing debt you already have.
  • Financing semi-stable investments with higher projected returns.

Mental Accounting

To let yourself accept this strategy, you have to mentally stop assigning debt to certain assets. For example, while I do carry a 1.9% car loan… it’s not money that was used to purchase the car; the money was instead used to replace part of our mortgage at 4%.

Now the debt that was used to pay for our house is spread across a mortgage, a student loan, a car loan, and 3 credit card balance transfers that will run for life. We save several thousand dollars a year by maximizing the uses of “bad debts”!

Taxes

One of the differences in comparing interest rates is obviously the tax impacts. I convert everything to an after tax interest rate to compare the interest rates.

Action Plan

I’m planning to hit up Penfed for some cheap money with their fantastic auto loan right now. In addition, I have my eye on a few new credit card offers that came in the mail. I’m also still working on finding a way to borrow money from readers directly.

So next time you look at a debt, instead of evaluating it on good or bad, try to mentally classify it based on cheap or expensive!





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Comments to There’s No Such Thing as Bad Debt

  1. How can you use the PenFed auto loan for paying off high interest loans? Do you enter information about your car and then they write you a check and I can use it to pay off my own debt?
    Is the interest rate set at 2.99% for the whole life of teh loan?

    (You can get a 2.99% auto loan at Penfed right now. And you don’t have to use it for a new vehicle, you can use it to refinance your current auto loan, use it to replace other higher interest rate debts, or even turn around and invest it in the 5% Certificates at Pentagon Federal.)

    Kelly

    • Hi Kelly!

      Yes, if you have a car that you own outright, they will send you a check.

      And yes, it’s 2.99% for the whole loan. Unbeatable, huh?

      Madison

      • Well I have a pretty low interest rate on my car already 3.99% i think, but it would be good to use for some higher interest credit card debt. So how would that work?

        Kelly


  2. I have the same question… I didn’t know you could use an auto loan for anything other than the purchase of an automobile.

    Jenn

    • Jenn, I think you confirmed what many people believe – we’ve been taught that loans need to be used for the collateral. It’s not always the case!

      Madison

  3. I second the first two commenters — I hope that it’s not really possible to take out an ‘auto loan’ and then use the money for whatever you want. If it is, then we haven’t really fixed the fast-and-loose lending practices that contributed to the current economic situation.

    Also, the conventional wisdom about good/bad debt is meant to make the same distinction that you make yourself later in the post – between appreciating and depreciating assets. Since most of us are stuck financing at least one depreciating asset (a car) in addition to investments and appreciating assets (houses, we hope) I think it’s just fine to have a rule of thumb to remind those who aren’t really interested in money that they should normally avoid going into debt to purchase things that go down in value.

    Stacy

    • Sorry Stacy, I’m not sure that I am against the idea of using a car loan for payment of items. I am all about the numbers and if I can pay off an amount that has +10% interest or so with a 2.99% loan I would use it for that. But I am not saying I would use it to incur new debt, just refinance old debt. The savings would help out in my debt reduction.

      Just wanted to clarify.

      Kelly

  4. Numerically – yes, everything you say is correct. But cheap credit is what got so many people in trouble financially to begin with in recent years. While you’re suggesting that people not get so “emotionally attached” to debt; that’s probably what we need more of in order to “deleverage” ourselves as a society.

    Matt

  5. i love this blog. i found you just last week through Million Dollar Journey. i can’t believe i didn’t find you before.

    i’m featuring a link to this piece on my blog today; because of you, i am seeking out a lower car loan rate and thinking about my debt completely differently. many, many thanks.

    by the way, I’m in DC too.

    lisaschamess

  6. here is the permalink to that post. your linkback is at “refinance my car at a lower rate”:

    http://tiny.cc/mlel1

    lisaschamess

  7. Debt at under 3% interest is a great deal, but only when used to buy an asset or necessary expense.

    It doesn’t matter how cheap debt is if it is used to live beyond your means – thus, the argument for “good” vs “bad” debt.

    Chris Parsons

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