Debt lessons

Today, Seth Godin (one of my favorite bloggers who usually talks about marketing) posted a great piece about consumer debt. Two great excerpts:

Here’s a simple MBA lesson: borrow money to buy things that go up in value. Borrow money if it improves your productivity and makes you more money. Leverage multiplies the power of your business because with leverage, every dollar you make in profit is multiplied.

That’s very different from the consumer version of this lesson: borrow money to buy things that go down in value. This is wrongheaded, short-term and irrational.

It takes discipline to forego pleasure now to avoid a lifetime of pain and fees. Many people, especially when confronted with a blizzard of debt marketing, can’t resist.

Resist. Smart people work at keeping their monthly consumer debt burden to zero. Borrow only for things that go up in value. Easy to say, hard to do. Worth it.

The general point of the article is that any time you go into debt for something that decreases in value, you’re making a bad move. This is a pretty clear take on “good debt versus bad debt” philosophy and using that perspective as a central rule of thumb helps you to make much better choices about your money.

Virtually anything you put on a credit card is bad debt. The stuff you buy with a credit card is either consumed (like food, for example) or decreases rapidly in value after you buy it (like a DVD, for example). Once you own food, you eat it and it no longer has any value. Once you own a DVD, you open the shrink wrap, turning it into a used DVD, which has much less value.

Student loan debt is (usually) good debt. Provided that you finish a degree program, student loans are usually good debts because the value of the degree you bought with that loan is much more than the face value of the loan. As we discussed yesterday, an education has such a huge positive impact on your lifetime earning potential that it blows away the value of your student loan. Of course, this requires that you take schooling seriously and complete what you start.

A car loan is bad debt. An automobile decreases in value with every mile you drive it – it will never reclaim the original price that you paid for it. Yes, it does provide transportation which can help you earn more money, but in that case, you’re talking about absolute minimal transportation – a mid-’70s Honda Civic bought for a few hundred dollars from a junkyard will get you from point A to point B.

Mortgage debt is (sometimes) good debt. A home will usually hold its value over time and perhaps increase a bit, but a home mortgage still isn’t always a good debt if you’re paying more in interest than you would be paying in rent living elsewhere. You should always strive to minimize the amount that you “lose” each month to housing, whether it’s in the form of rent or in the form of mortgage interest.

Financing any consumer purchase is bad debt. Furniture? A television? A riding lawn mower? All of these things are often bought with a financing plan – and all of them are bad things to go into debt for because they drop steeply in value as soon as you buy them.

But I need all of this stuff that depreciates! If you need a lawnmower and can’t afford it, buy a very low-end push mower and start saving for a better one. You need only to mow your yard, so get the item that covers what you need, not what you want.

If you need a car, head to the used car dealership and look at the $1,000 section. You need only to get from point A to point B, so get the car that covers this basic need, not the shiny features you want.

If you need a new couch, head down to Goodwill. You need a place to sit, but you only want something shiny and expensive from the furniture store.

I don’t begrudge anyone a nice shiny car or a great riding lawn mower or some new furniture or a flat-panel HDTV. But those things cover your wants, not your needs. Don’t go into debt for them. Cover your needs, then save up for your wants.

The most interesting thing? Once you start separating your needs from your wants, you discover that you don’t actually want a lot of that stuff too much after all. If you have a working lawn mower, after all, the desire for a replacement is quite a bit lower.

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