Good Debt: The 5 Best Reasons to Borrow Money
by John Persinos
There's been much talk about our nation's debt level and its burden on future generations. And as one asset bubble after another has popped, leaving behind only the mountains of the debt we accumulated to buy into those bubbles, we're slowly but surely being conditioned to think that all debt is bad.
So brace yourself for a bit of modern-day heresy: Some debt is good.
It's certainly true that too much of the wrong kind of debt is severely debilitating -- and should be avoided. But there are circumstances when you can use the right kind of debt to your long-term advantage.
In fact, in certain situations, I could argue it's irresponsible NOT to incur some debt. You can use debt to invest toward making future income, increase your net worth and build an asset base to use in retirement. The trick is to only borrow for things that can appreciate in value.
I've put together a list of my 5 favorite investments that should be bought with at least some debt. Here they are, in no particular order:
1. Home Loans for a Place to Live
Look past the scars of the last housing meltdown. Sure, the days of using your home as a de facto ATM became outdated. But buying a home still makes sense.
It's supposed to work this way, and it still can: you buy a home, work patiently to pay off the mortgage, and then eventually enjoy owning and living in a mortgage-free dwelling. In the meantime, you can take advantage of the mortgage interest deduction on your taxes -- one of the few significant IRS breaks available to the middle class.
Despite past talk on Capitol Hill about eliminating the mortgage interest deduction, don't believe it for a second. The realtor, mortgage and home building industries employ armies of powerful lobbyists that would never let it happen. It would be like repealing baseball and apple pie. And once you're able to qualify for this all-American tax break, it opens the door to other forms of itemization on your tax form.
[Ready to buy a home? Use our Mortgage Calculator to see what your monthly payment (including principal and interest) would look like. To maximize your savings in interest, check out these 3 Sure-Fire Steps for Finding the Lowest Mortgage Rates.]
2. Mortgages for Investment Properties
If you're of relatively modest means but still want to invest in tangible real estate, your best bet is to buy a second home and become a landlord. As a landlord, you're able to build equity in a house and enjoy the tax benefits of the mortgage interest deduction -- but your renter is making the monthly payments for you.
You also can deduct on your taxes any home improvements or money spent as a landlord. It's a sweet situation. The keys are to a) not overpay for a property, and b) carefully screen prospective renters. You'll want to find responsible tenants who'll serve as guardians of your investment.
[Caution: Don't buy an investment property without knowing the 5 Homebuyer Mistakes Everyone Makes.]
3. Student Loans for Education
Whether you're borrowing for your kids' education or your own, college can seem prohibitively expensive. But it still counts as one of the best possible investments you can make for your children's future or your own. A worthwhile college experience should provide both tangible and intangible resources for a future career, and should also help hone marketable skills valuable in a global economy.
Countless studies confirm that college graduates make considerably more money over their lifetimes than those without a degree. And if you're seeking a mid-life career change and want to obtain a Master's degree or doctorate, the additional debt can be a worthwhile investment in your personal growth and future earning potential.
[Minimize your borrowing needs with 7 Insider Secrets to Getting College Scholarship Money.]
4. Home Equity Loans for Certain Home Improvements
This is for responsible users of home equity loans only -- those of you who plan to use it for home renovations. Home improvements generally fall under two categories: logical and ludicrous. Adding value isn't always as obvious as it seems, and spending money on improvements that won't pay off in the long term is not smart. But if you stick with projects that are likely to pay you back in the form of a higher sales price, borrowing to complete them can be a good investment.
The litmus test is whether the improvement will make the eventual buyer of your home happy -- not how you feel about it. We talk about this in greater detail in The 9 Best Ways to Add Value to Your Home.
5. Home Equity Loans Used as a Cash Management Tool
When irresponsible homeowners took out home equity loans back in the housing bubble's heyday they generally squandered the money on cars, boats, vacations, and flat screen televisions. That's what I refer to as BAD debt. But if managed properly, a home equity loan can enhance your wealth building goals.
Take a cue from small, well-managed businesses that borrow for short- or intermediate-term purposes -- but then make a point of paying off that borrowing in a pre-determined timeframe. If used for targeted purposes, a home equity line can serve the same purposes as a line of credit taken out by a small company. You can use it to retire higher-interest debt or free up cash flow. Just don't use the money to take your wife to Maui.
Used wisely, good debt can give you access to wealth-building opportunities that may have been beyond reach. If the thought of risking your home or your future wages puts you on edge though, you may consider taking out a low-interest personal loan, which allow you to finance almost anything without needing to put up collateral. Personal loans may also carry lower annual percentage rates (APRs) than credit cards, which could potentially save you thousands of dollars in interest charges over time.