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When Good Debt is Bad

We know the old adage: never go into debt for depreciating assets. For a long time, the conventional wisdom has been that bad debt are things like credit cards, appliances, and things that lose their value quickly. At the same time, many people regard two types of debt as “good debt”. These are mortgage debt and education debt (or student loans). But, are these really good debt? What happens when making payments on a mortgage or student loan debt instead of paying down an investment in the future become more like a ball and chain holding you back from things? How can appropriate boundaries on this debt be set? Consider the following:

–What is a realistic estimate of your future income? — the main problem that I find with servicing mortgage and student loan debt is the unrealistic forecast many people have of their future stream of earnings. Sure, when starting out, an entry level wage typically goes up. However, a realistic worker today needs to consider that regular annual pay raises have not been part of the median worker’s experience in America. In addition, most people will experience some income uncertainty from layoffs, furloughs, lower bonuses, and stints between jobs (intentional and unintentional). This income irregularity needs to be part of planning of paying off large debts.

–What flexibility is given up through these debts? — one of the saddest conversations that I’ve had with friends and co-workers recently has been around those that feel chained to a job they hate because of large debts hanging over their heads. For graduate school debt, sometimes over $100,000, I know many people that have opted for corporate law or banking in order to pay their debts down. This is a huge barrier for many people wanting to go into public and community service roles. Mortgage debt, or the inability to quickly sell a house, also seems to be a barrier in quitting a job, moving to a new location and other problematic features of having a huge inflexible, and illiquid liability. With the shine on housing finally dulled, perhaps more people won’t continue with the false mantra of “housing only goes up”.

–What is the payoff period of the loan? — at the age of 18, when most people take out their first student loan, it’s hard to comprehend what a decade really means. With some of the large student loan balances, many people are committing themselves to a payment over $1000 a month, each month, for over 10 years. With most mortgages, people tend to sign up for a 30-year loan. Are you really prepared to service these loans for 10 or 30 years, respectively?

–What is the opportunity cost? — in addition to flexibility, servicing large loans often means having to give up future purchases and activities, or threaten future retirement schemes. While it may be worth it to many people, it pays off to take a long, hard look at the trade-offs before engaging.

–What are the alternatives? — I’m certainly not advocating for people to forgo their education, but I do think that people should consider lower cost alternatives more than in the past. For a mortgage, downsizing expectations, or deferring a house purchase for a year or two to accumulate a larger down payment, is straightforward. For education, I recommend that people consider lower cost options like state schools and community colleges, especially if they are planning to get a second degree. Also, looking at programs that help to pay down debt in exchange for public service. Unfortunately, it looks like Harvard Law School just suspended this program as it looks like too many people had the same thought.


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