I got a bit of a giggle when someone I respect told me her definition of good debt was debt she could pay, and bad debt was the debt she could not pay. I understand where she is coming from. She has some she cannot pay, right now, and that is causing her immediate worry. It might spoil her weekend.
At a base immediate level this definition might seem to make sense. However as a business person this definition is seriously lacking. Why? Because this definition completely misses it's mark. Why debt is helpful to both debtor and creditor; and why it is not.
Debt is tremendously beneficial to our wellbeing, and our economy. However this applies to good debt. Bad debt is tremendously harmful.
Think of it like fire. Contained in our furnace fire is very beneficial to keep our homes warm. Uncontained it can easily destroy the home.
Or like your car; tremendously useful when used properly; lethal when used improperly.
Good debt is debt that enables you to create value.
Bad debt is debt that is incurred without increasing value, or even worse incurring additional expenses.
Example 1:
You are in a position to help people hear, but you need a space to do so. You don't have the cash to build or buy your own office so you use one someone else has already built. You incur debt, an obligation to pay someone money, and in exchange you receive a space to serve your customers.
The debtor now can create value, where they couldn't before, to pay the debt.
This is a very common debt for businesses. The lender gets regular cash from the debtor, and the debtor gets space to create value. Each wins.
This is a typical good debt situation.
Example 2:
Your current car runs and the last payments were just made, but you really want a new car. You don't have the cash to buy one. You incur debt, an auto loan, and in exchange you receive the keys to a new car.
The debtor cannot create any value they couldn't before. Sure the new car is nicer, bigger, fancier, but it doesn't go any faster or anywhere the old car wouldn't go.
This is a very common debt. The lender gets regular cash from the debtor, and the debtor gets to drive a new car. Does each win?
The lender does win because they get monthly cash. The debtor is not so lucky. The debtor now needs to pay higher insurance premiums, in addition to paying out real cash each month, and they cannot create any real value they couldn't do before. The debtor not only has added expenses to their financial situation, they need to pay a debt to add those expenses.
The debtor also has the stress and worry about making each monthly payment. They may now feel enslaved to their employer because if they lose their job they will lose the care.
The debtor looses big time.
This is a typical bad debt situation.
If you have questions about how to evaluate your current debt, or debt you are considering incurring please contact me and I would be glad to assist you.
I know this will help some of you.
Rick
