Of Good and Bad Debt

Posted at August 6, 2009

Get Ahead Series

Have a quick look at those two men over there; Steve and James. They have the same education; same job type, and are of the same age – but have different outcomes in life. Steve had a knack for accumulating credit card debt; James focused on wise investment loans. Today they live in different worlds; albeit next to each other.

To get ahead in life, you have to really understand the difference between good and bad debt. Good debt takes you ahead in the long term while bad debt pulls you back.

The Allure of Bad Debts

As your income increases, credit card companies, car loan companies and other sharks will be baying for your blood. They will give you the most compelling offers. You see those offers all the time, if you cross a certain income bracket. For only a small monthly repayment, you can get to live in your dream house, have your dream accessories and drive your dream car.

Graphic designers do booming business for the bad debt peddlers. They will come up with interesting ways of showcasing the kind of life you can live, the glory, the luxury, the majesty. They will play with emotions that you did not even realize you had.

The fancy pitches of bad debt salesmen can blind you. They can get you to stop thinking about the future. Why wait when you can have it now? Why not get that new fridge on credit? Why not pimp up your brand new ride for a low monthly payment?

Enter Steve …

Steve got caught up in what I like to call the credit mess. He got a phone call from his bank telling him that he had been pre-approved for a car loan. He had not even thought of buying a car! Then they told him he had 2 months to think about it before the “pre-approval” expired. Instead of taking time to go think about whether it was right or wrong for him to get a car on loan, he started hitting the pavement to the dealerships.

He took a friend with him and shopped with the confidence of a man who has the cash in his pocket. His demeanor changed, he walked with a spring. He was on cloud nine. The car sales men made him feel like a king. They were there to serve him. They showed him around the dealership. Was he looking for a used car or a new car? He did not care. He had the pre-approval to buy anything his heart desired.

Even before the 2 months period elapsed, he had signed the dotted line. He had a brand new BMW, metallic paint, alloy wheels, tinted windows, leather seats and a million other add-ons that that the car salesman had suggested. The extras alone had cost a small fortune, but it was a “negligible” addition to the monthly payments over 5 years.

As he drove off the dealership, he realized that he felt different. Same guy, different car – and people were already treating him different. He loved the attention of the ladies. Oh the power of debt. He felt like a rich royal. All he had to do was make the monthly payments and life would always be this good. He wound down his windows and saw all those flashy cars on the streets…he wondered…how many others are driving financed cars just like him?

The good life …

He got invited to more parties. More people wanted to hang out with him. He now felt like he had to upgrade his wardrobe. It was long overdue, he justified himself. What does he do at this point? He whips out his Visa credit card.

After being invited to a few parties, he felt like he had to return the favor. He wanted to hold a birthday bash at his own house. Then it hit him that he lived in a very humble house compared to his friends. It was time to make a move. He moved to bigger house, it needed furnishing, nice furniture for a man with “class” like him. So he whipped out his MasterCard credit card.

The deeper he got into debt, the more he enjoyed life. The more he enjoyed life, the more friends he made. All his new friends were in similar situations. They were all on a high. Debt is like a drug. It is addictive yet alluring, but with deadly consequences.

What Steve did not realize was that one bad debt begets another. One spendthrift friend begets another. The banks love people like Steve. They are their bread and butter. They provide them with the insane profits; profits that make bank shareholders happy. What Steve pays as interest, they call it “income”.

Good Debts to Get Ahead

On the other hand, James preferred to live within his means. He got tempted all the time to take up credit card and car loan debts at very friendly terms, but he would hear none of it.

To a person looking at Steve and James from a distance, Steve would have seemed to have made it. He had all the flashy possessions to prove he was “rich”. But if truth be told, James was content to live within his means. He was proud of his budgeting skills. He was proud that he was playing the financial system in his favor, not the other way round.

James took the bus to work. Sometimes he would take his beat up Toyota to work. It was just a car that took him from A to B, but it was his. Not owned by a bank or a finance company. He made no monthly repayments for it and did not have to change his living conditions to accommodate the image brought by the car.

He had good friends that had known him for years. Their social lives involved interactions based on a lot more than material possessions.

James did have debts also, but his debts were geared towards investments. He borrowed from the banks to buy and build property. He was disciplined in making his repayments and maintaining a good credit history with his lenders. He never borrowed more than he could comfortably service.

He would do his homework well before he signed the dotted line. He understood the time value of money. Sometimes he let some opportunities pass him by if he did not think that he understood fully what the investment would mean for his future cash flow.

In Summary

To get ahead in life, you need to seriously evaluate what kind of debts you get into. Are you buying an asset or a liability? Are you going to be able to service that debt without adversely affecting other areas of your life? Do you have to take that particular debt?

You can leverage debt to get ahead in life, but be careful about car loans, credit card loans and other consumer loans. If you have to take on debt, lean on the side of investment loans and even then, make sure you do your home work well.

Please share this article (and blog) with your friends. I would love to hear your comments. Please share your experience, thoughts and ideas regarding good and bad debts in life.

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