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Good debt - Bad debt

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The difference between “good” and “bad” debt

Personal debt is usually reported in a negative light, it’s important to distinguish between the different types of debt:

Good debt. This type of debt is taken on as a way to build wealth in the long term. For example, a home loan allows you to work towards owning your own home, and an investment property mortgage allows you to earn income from property you rent out or re-sell at a higher price.

Bad debt. This type of debt diminishes your wealth over time. This means it is not attached to an asset, and usually indicates you have paid for items or services you would not be able to afford based on your income. For example, relying on a credit card for non-essential items, or those that diminish in value over time, would lead to bad debt.  finder.com.au

 

The article is about Australia’s personal debt, but there are broad similarities universally.

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Good debt. This type of debt is taken on as a way to build wealth in the long term. For example, a home loan allows you to work towards owning your own home, and an investment property mortgage allows you to earn income from property you rent out or re-sell at a higher price.

Presumably sub-prime debt isn't good debt even if it notionally "allows you to work towards owning your own home".  After all it's supposed to be one of the main reasons for the economic collapse.

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Bad debt. This type of debt diminishes your wealth over time. This means it is not attached to an asset, and usually indicates you have paid for items or services you would not be able to afford based on your income. For example, relying on a credit card for non-essential items, or those that diminish in value over time, would lead to bad debt.

So is debt for a sound business venture bad debt - just because it's "not attached to an asset".

Seems like the definitions need a bit of refining.

Also taking their definitions a bit further then central banks policies seem to be bad policies because they diminish most people's wealth over time - through real inflation etc etc - and benefit those with assets.

 

Edited by billybong

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Doesn't "good debt" rely on the availability of long-term, well paid jobs (careers), which are being eroded by automation, globalisation, etc? Good debt is turning into bad debt with the disappearance of the traditional career.

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Sounds a bit like Rich Dad Poor Dad, a very HPI personal finance self help guru guy. Some of it makes sense, lumping things into assets and liabilities. A mortgage is seen by many as an asset but since you are merely renting it from the bank its more a liability. If you were making a profit from btl then its more of an asset. 

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Good debt  ....... "property you rent out or re-sell at a higher price" - it imply you can't go wrong with bricks and mortar, and property debt is good because you can make only profit and the value is only rising.

Edited by rollover

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3 hours ago, thisisthisitmaybe said:

Doesn't "good debt" rely on the availability of long-term, well paid jobs (careers), which are being eroded by automation, globalisation, etc? Good debt is turning into bad debt with the disappearance of the traditional career.

In essence, yes. Good debt generates improvements in productivity, which translate in turn into higher profits, higher wages and growth in current demand. A virtuous circle. Bad debt, on the other hand, primarily generates asset price inflation.

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4 hours ago, billybong said:

So is debt for a sound business venture bad debt - just because it's "not attached to an asset".

Seems like the definitions need a bit of refining.

Also taking their definitions a bit further then central banks policies seem to be bad policies because they diminish most people's wealth over time - through real inflation etc etc - and benefit those with assets.

 

The original definition looks fine.

Good debt is wealth generating.

So even sub-prime debt is just fine, when you are the debtor and paid off your loan.  (The only issues with sub-prime were the loan holder losses due to defaults, not those that paid their sub-prime loans off).  By definition sub-prime is more risky as more people tend to default as they are on the edge of loan affordability.

With a business the definition is just the same, wealth generating in a business usually means allows you to maximize a profit, for this to happen the access to money today allows a business venue to take place at all or allows an opportunity cost to be exploited, but the business venue needs to pay back the capital and the interest and still make a profit on top to be wealth generating.  Maybe it leaves the business with additional capital assets, that would also be covered under the wealth generating term.

 

A good debt can turn into a bad debt during the loan lifetime.  Not limited to but including: the debtor defaults (now it is not wealth generating).  The conditions change that allowed the wealth to be accumulated for the debtor over the loan lifetime (Negative equity, in business not enough budget for business goal to be achieved, in business market conditions changing wrong product, wrong price, wrong time).

The thing about loans is you are locked into that 'is this wealth generating' decision from day one until you close the loan contract, that is the debtors risk.  The loaner is already making their money from the interest payment no matter what.

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1 hour ago, Odin said:

The original definition looks fine.

Good debt is wealth generating.

So even sub-prime debt is just fine, when you are the debtor and paid off your loan.  (The only issues with sub-prime were the loan holder losses due to defaults, not those that paid their sub-prime loans off).  By definition sub-prime is more risky as more people tend to default as they are on the edge of loan affordability.

With a business the definition is just the same, wealth generating in a business usually means allows you to maximize a profit, for this to happen the access to money today allows a business venue to take place at all or allows an opportunity cost to be exploited, but the business venue needs to pay back the capital and the interest and still make a profit on top to be wealth generating.  Maybe it leaves the business with additional capital assets, that would also be covered under the wealth generating term.

 

A good debt can turn into a bad debt during the loan lifetime.  Not limited to but including: the debtor defaults (now it is not wealth generating).  The conditions change that allowed the wealth to be accumulated for the debtor over the loan lifetime (Negative equity, in business not enough budget for business goal to be achieved, in business market conditions changing wrong product, wrong price, wrong time).

The thing about loans is you are locked into that 'is this wealth generating' decision from day one until you close the loan contract, that is the debtors risk.  The loaner is already making their money from the interest payment no matter what.

 I think you've just done a bit of refining of the definition there.  The original definitions posted need some more paragraphs.

I can't agree that when sub-prime contributes to the collapse of the global economy that it can ever come under the category of Good debt - not at the levels evident and all the redistribution of responsibility and other shenanigans that has gone on in trying to resolve it.

Edited by billybong

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4 hours ago, Pieman Pieface said:

Sounds a bit like Rich Dad Poor Dad, a very HPI personal finance self help guru guy. Some of it makes sense, lumping things into assets and liabilities. A mortgage is seen by many as an asset but since you are merely renting it from the bank its more a liability. If you were making a profit from btl then its more of an asset. 

To be fair to him. He wrote his book a while ago. Most smart people invest in the highest return asset of the day. so perhaps hes into other things now.

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the 'good debt' example given is very revealing...why not give an example of borrowing to invest in the productive economy...i wonder?

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2 hours ago, billybong said:

I can't agree that when sub-prime contributes to the collapse of the global economy that it can ever come under the category of Good debt - not at the levels evident and all the redistribution of responsibility and other shenanigans that has gone on in trying to resolve it.

This was a special situation, "ingenious people" managed to package up sub-prime and hide it inside MBS and export the risk to someone else.  The "ingenious people" were simply ripping off other international banksters and running off with the money after it was transferred into less risky stuff.  So this made the sub-prime market look like money could be made out of it at the point of sale, because those selling it didn't also need to hold onto the risk.  So other bankster sucker was unknowingly holding that risk.

Sub-prime itself it not a problem when it is not hidden so the risk is correctly assessed by all those involved in handling it, if this has of been the case originally there would be no sub-prime bubble as banksters would have stopped buying so much of it up; which in turn would have throttled the ability to sell it.

So I am saying here separate the concern of a "sub-prime market" away from the recent "sub-prime market behaviour" that has occurred.

 

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3 hours ago, Odin said:

This was a special situation, "ingenious people" managed to package up sub-prime and hide it inside MBS and export the risk to someone else.  The "ingenious people" were simply ripping off other international banksters and running off with the money after it was transferred into less risky stuff.  So this made the sub-prime market look like money could be made out of it at the point of sale, because those selling it didn't also need to hold onto the risk.  So other bankster sucker was unknowingly holding that risk.

Sub-prime itself it not a problem when it is not hidden so the risk is correctly assessed by all those involved in handling it, if this has of been the case originally there would be no sub-prime bubble as banksters would have stopped buying so much of it up; which in turn would have throttled the ability to sell it.

So I am saying here separate the concern of a "sub-prime market" away from the recent "sub-prime market behaviour" that has occurred.

 

Call it extreme and massive sub-prime home loans or something but it's still not Good debt if the extent and nature of it helps to collapse the global economy.  

Bearing in mind that the only example their original definition of Good debt gave was that of home loans. 

Edited by billybong

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Debt used for investment = good
Debt used for consumption = bad

Technically mortgages can be either of these, using one so you can move closer to work, or provide security to your family = good, using a mortgage to get a house with a snazzier kitchen = bad

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the 'good debt' example given is very revealing...why not give an example of borrowing to invest in the productive economy...i wonder?

I had the same reaction- I was expecting the 'good debt' example to be borrowing to expand a business or for self education- instead we get a decaying pile of expensive to maintain bricks as our primary model of 'good debt'???

As you say very revealing.

It's as if the idea of houses as investment vehicles has become so embedded in the collective unconscious that even buying a home just to live in is now seen as a cunning investment strategy. So what used to be viewed as a burden-a mortgage- is now viewed as a badge of honor- proof of your membership of the speculating classes, even if all you ever do is live in the bloody thing.:lol:

Perhaps it's because HPI is now so taken for granted that it's seen as intrinsic to the house buying paradigm- so to borrow to buy a house is by defintion 'good debt' because some other poor b*stard will be paying more for that house in the future.

Of course the real failure of this idea is that as more disposable income gets sucked into the great housing ponzi the real economy from which this debt is to be repaid declines as demand falls- so the 'good debt' of a mortgage gets transformed into the 'bad debt' of defaulting home owners whose jobs and incomes are undermined.

The funny thing is that in any other context the idea that borrowing to buy a decaying asset in constant need of repair and maintenence could ever be a good investment would be laughable- imagine a guy buys a ten year old car on credit-a car with zero vintage or collector value- and then tries to tell you that it's a good investment and a good use of debt.

Only in a world with HPI forever as a core assumption could borrowing to buy a house be defined as 'good debt'. A mortgage is not 'good debt'-it's just a debt.

 

Edited by wonderpup

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The author seems to be ignoring the negative impact of 'good debt' when used to by any sort of asset, 'good' (a house, apparently) or 'bad' (cocaine, allegedly) - namely, that the price goes up to match the available credit.

As others have said, debt for investing in a business seems a better example, but I'm not entirely convinced that 'good debt' really exists. Existentially, it's just allowed us to eff things up faster than we would have been able to otherwise, as well as evolving an economic system that can only be maintained by perpetual growth in a finite world.

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Good debt adds value, appreciates, like quality debt for a quality business, debt that is campari .....bad debt is for short-term consumption things that depreciate.......like buying a meal on a credit card and paying for it months later plus interest when have forgotten what you ate and what paying for.;)

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3 hours ago, Upabove said:

Debt used for investment = good
Debt used for consumption = bad

Technically mortgages can be either of these, using one so you can move closer to work, or provide security to your family = good, using a mortgage to get a house with a snazzier kitchen = bad

Otherwise known as self-liquidating debt and non self-liquidating debt.

Example : I buy a pick up truck so I can start a landscaping business. The truck allows me to go out and earn money to eventually retire the debt leaving me with a depreciating asset that still generates an income. This is self liquidating debt.

I buy a pick up truck just to drive around and show off to my neighbours. I have to retire the debt through other income leaving me with a depreciating asset that just depreciates further. This is non self liquidating debt.

This comes from Robert Prechter's Conquering the Crash.

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