When it comes to debt, financial experts have typically marked both “good” and “bad” scenarios. But in today’s touchy economy, the lines are becoming blurred.
To avoid stacks of unpaid bills, many of us are turning to cash instead of pulling out plastic for purchases. That’s a smart move according to a recent study in the Journal of Experimental Psychology: Applied (American Psychological Association), which found fresh evidence that if you’re looking to curb spending, cold hard cash is the way to go. “The more transparent the payment outflow, the greater the aversion to spending, or higher the pain of paying.”
Sarah Evans, director of communications for Elgin Community College (ECC), has made a concerted effort to stick to cash these days in order to avoid debt. “My husband and I accrued a lot of debt right after college,” says Evans. “We used credit cards to make ends meet, buy our professional wardrobe, even for groceries. It took about two-and-a-half years of dedicating the majority of our financial resources to paying it all off.” Now, Evans and her husband pay cash or debit for major purchases. “If we decide to open a credit card to save money on a purchase, we pay it off the next month.”
Get Smart: Examining the Varying Degrees of “Good” Debt
There are some purchases that have long been deemed worth going into debt for – education, for instance. “Education is the one investment no one can ever take away from you,” says Evans. “It is not market-dependent, nor will it ever decrease in value. I am confident in my conscious choice to go into good debt for higher education.” Amy Perrin, director of student financial assistance at ECC, echoes Evans’ sentiment. When she advises students and parents about the cost of college, she asks they consider the benefits of having a degree.
Education is like any other venture, says Perrin, and you should compare the upfront financial obligation to the rate of return on your investment. “My experience has been that the rate of return far outweighs the risk,” she says. “I advise students to apply for financial aid early, research scholarship opportunities, and borrow only what they need to cover costs.” Coming from a community college environment with low tuition costs, Perrin feels confident telling students higher education is a profitable and wise opportunity.
But is it also wise to go deep into dept for a pricey education – believing that borrowing for your degree is a smart choice regardless of the cost? It’s not so simple, says Robert Pagliarini, president of Pacifica Wealth Advisors, Inc. and author of the bestselling The Six-Day Financial Makeover. “Experts have said education debt is always good debt, but I completely disagree.” According to Pagliarini, it’s like saying food – any kind of food – is good. We all know that’s not true. It’s got to be the right kind of food. He feels going into debt to get a degree or to increase your skills is smart if it will translate into a better job and more money. “Do not borrow $50,000 just to get a degree that you’ll never use or that won’t move you forward. You’ll have a nice diploma, but you’ll also be plagued with debt for a long time.”
Even knowing her education-related debt was a necessity, Evans still intensely worried about her credit score when she and her husband purchased their house two years ago. “The night before we got our scores reminded me, ironically, of the anxiety the night before a college exam. Luckily, we didn’t have much to be concerned about. In my case, the credit score worry was situational (the purchase of a home). While it is not on my mind daily, my husband and I do our best to practice good financial habits.”
So What, If Anything, Is “Good Debt”?
According to Manisha Thakor, co-author of On My Own Two Feet: A Modern Girl’s Guide to Personal Finance, it’s worth going into debt for a house you can afford. For most people, this means buying a property that is roughly three to three-and-a-half times their annual household income.
Another debt-green light: A car to get you to work. If you must have one, says Thakor, the purchase price should ideally be no more than 30 percent of your annual income. Additionally, try to put 20 percent down on a loan that is no longer than five years.
Bottom line: The best kind of debt is debt you can afford. This means debt that has monthly payments sufficiently low enough that you can pay it down while meeting all your other necessary living obligations (and a few fun ones, too) with cash.