In September, we wrote about controlling so-called “bad” debt, which you’ve accumulated buying things that you don’t really need and which do not appreciate in value. And it also encompasses buying an extravagant, high-end version of something that you do actually need. Everyone needs shoes and most Americans need a vehicle, but if you buy expensive Jimmy Choo shoes on credit or go deeply into debt to buy an expensive, new-model-year convertible, you are racking up bad debt.
Now we’ll look at the other side of the coin by reviewing three of the most common loans that are seen as “good” debt. First, what constitutes a good debt? A debt that is considered good is one accrued to pay for something that you need – not just something you want – and something that is expected to appreciate in value over time.
Although there is no guarantee that your home will increase in value over the years, historically, that has been the case, so mortgages are usually considered to be good debt. This is true especially in cases where you plan on staying in one location for the long haul and where the alternative to a mortgage (renting) is expensive. In the nearly 20 years that I have lived in my suburban Chicago condo, for example, I have accrued over $100,000 in equity in my home. Although I took on mortgage debt to make the purchase, I know that it was a good debt for me, because apartments are expensive here, and if I had been paying rent for all those years, I would not have any equity to show for the 200+ rent checks I would have written. To learn more about factors to consider when deciding whether a home purchase and mortgage is a good debt for you, check out our recent blog post, Is it time to stop renting and buy a house?
A loan to make needed improvements to your home is often a good debt, especially if the loan is a low-interest-rate, tax deductible1 home equity or home equity line of credit loan and is used to make improvements that increase the resale value of your home. Not all remodeling projects have the same value, though, so do your homework to find out if an improvement will actually increase the resale value of your home. Want to figure out if a home equity loan is a good debt for you to take on for your home improvement project? Our recent Alliant Home Advisor newsletter article on the expected return-on-investment for popular home improvement projects, is a great place to start your research.
A loan to further your education is usually a good debt, as salaries tend to rise along with the level of education you attain. There are, however, some scenarios in which student loans might not be considered as good debt – when you’ve gone deeply in debt training for a career with low pay expectations, for example. Author and personal finance expert Jean Chatzky recommends that students limit the amount they borrow for college to the amount that they can expect in a starting salary. So if you’re studying to join a profession that will pay you around $40,000 a year when you graduate, you should try to keep your student loans at around $10,000 per year to stay on the “good” side of the debt continuum. If you’re studying for a higher-paying profession, a larger loan to attend a high-priced, prestigious university might still qualify as a good debt for you.