56–Lever #5: Interest Paid (Part Three–Is There Good and Bad Debt?)
Not all debt is terrible, just most of it
When it comes to debt, you’ve probably heard the phrase “good debt vs. bad debt.” It’s catchy, but not always helpful. In reality, most debt isn’t good or evil—it’s better to think of it as bad vs. not-so-bad.
I wrote in an earlier article that borrowing is not a sin, but just because the Bible doesn’t specifically prohibit borrowing doesn’t mean that all debt is good. On the other hand, some debt may be better than other kinds, based on a variety of factors.
As you can see in the graphic below, there are basically six kinds of debt: mortgage debt (1st and 2nd mortgages, including home equity lines of credit—HELOC), student loans, business debt (not shown), auto loans, revolving credit accounts (credit cards), and investment debt (margin loans).
If we look first at the “bad” end of the spectrum, we see things like car loans and credit card debt. What these have in common is that they tend to be fun stuff that depreciates such that, eventually, you may owe more money for them than they are worth. There’s another similar problem that most people don’t think about when they finance a car. If it’s in an accident, even if it’s not your fault, and it’s totaled, your auto insurance company may not pay enough to even cover the loan because of rapid depreciation, which can leave you on the hook for the difference.
Sure, those clothes, new gadgets, new car, or vacation are fun while they last, but they lose their value quickly.
Another characteristic of "‘bad” debt is that it tends to carry high interest rates. A notable example of this is credit cards, where the APR is often 18% or higher.
And finally (and this is a biggie), this kind of borrowing tends not to improve your future wealth (W). In fact, (IP), as we’ve discussed earlier, is a negative. For example, putting $2,000 on a credit card for concert tickets and new clothes might feel fun in the moment, but you’ll likely be paying that off for months, plus interest. There’s no lasting return except perhaps the lingering regret when the bills come due.
Now let’s look at the other end of the “debt continuum”–what about “not so bad” debt? Not-so-bad debt is still bad in the sense that it’s still a liability. However, not-so-bad debt can work in your favor when handled wisely. For example, student loans can be “not so bad” to the extent that they lead to a degree that qualifies you for a job or profession with significantly higher earning power. A home mortgage, if used to purchase a reasonably priced home, replaces rent, and you may build equity over time. A small business loan (not shown on the diagram) can help you start or grow a business with good income potential.
But none of these types of debt is risk-free. And they all carry an expense (IP) and negatively impact your financial life equation (FLE). A degree in a low-demand or low-pay field, buying a house beyond your means, or taking on business debt without a solid plan can quickly turn a not-so-bad situation into a very bad one. But with wise planning, these debts can create long-term value, and therefore make sense in the short term.
Sometimes, debt can help solve a problem that can’t be solved any other way. However, it’s preventable most of the time. An emergency fund can address a sudden, unexpected expense or something more challenging, such as a medical emergency or job loss. (And don’t spend that emergency fund to buy a house—you may need it sooner than you expected.) However, depending on the severity of the financial problem, an emergency fund may not be sufficient to address it. This is where having the right kind of insurance comes in. Even then, insurance may carry a high deductible.
Here are some questions to ask before taking on any debt:
Is this debt funding something that will appreciate (go up) or depreciate (go down) in value?
Can I realistically afford the payments without sacrificing generosity, saving, or margin?
Will this decision serve my future, or satisfy a desire I have in the present?
What does the Bible say about my situation?
The Bible will seldom ever say “buy this but don’t buy that” or “borrow for this but not that.” But in terms of biblical principles, debt is never praised; it’s often viewed as something to avoid if possible. (However, the ability to lend to assist others, without interest, is commended, perhaps because it implies a surplus.) But that doesn’t mean carrying debt is sinful or always foolish. It means that if we must borrow, we should be wise and cautious.
Sometimes, debt may be the only viable option (especially for expenses such as education or housing). But we should approach it with humility and a plan to repay it as quickly and responsibly as possible.
Most young adults need a place to live and some form of transportation. I’ll discuss the former in a future article about buying a house. My simple advice when it comes to borrowing to buy a car is to try to pay cash if possible, and buy a car that is at least 2 or 3 years old (someone else has already taken the depreciation hit). Borrow for as short a time as possible and pay it off quickly. And don't trade in a car that you still owe on for a newer/better car at the same payment amount—that will only extend the term of the loan, and you’ll end up paying a ton more interest.
Finally, avoid “buy here, pay here” predatory lenders. Enough said.
No matter what, a good question to constantly ask yourself is, “Is this building my future wealth or borrowing from it?” That kind of thinking will keep you from being trapped in loans with debt payments you can’t afford, and help you grow as a wise steward of God’s resources.
For reflection: You may have already learned that debt is easy to enter and hard to escape. But instead of asking whether a loan is “good” or “bad,” a better question might be: “Does this debt enslave me or contribute to financial margin and freedom in the future?” The big question is, “Do I really need this loan, or is there another way?” Scripture warns us about the dangers of becoming a slave to debt, not because debt is inherently sinful, but because it can misdirect our scarce resources, erode our margin, and impede generosity. Wisdom calls us to count the cost, avoid presumption, and seek counsel before signing on the dotted line. How have you thought about taking on debt in the past? What would a more God-honoring approach to borrowing look like in your life?
Verse: “The rich rules over the poor, and the borrower is the slave of the lender” (Proverbs 22:7, ESV).