I saw something interesting on the yahoo main page today. It is an article called The Myth of Good Debt. Certainly it is good for a coffee break or a few minutes of internet time wasting.
The whole subject of "good debt" vs bad debt has always kind of bothered me. Plain and simple debt is bad. You are promising future earnings for something now. You are almost surely paying interest for this service.
To be honest I think it is more like kind of bad debt and really bad debt. I would characterize home mortgages and education is kind of bad and consumer debt, credit cards, car loans and the like and really bad debt. The label good implies that it is smart to have this debt and it does great things for you. Sometimes that is right. In particular getting a college degree greatly increases (on average) your earning power. If you could figure a way to get through school with no debt or low debt that is ideal. However since educational costs have increased greatly beyond inflation or typical low level (working your way through school type job) wages that isn't always realistic.
Tangent begins- Also I would submit to some people that working your way through school at a low paying job and taking classes part time isn't the best route anyway. I have known a lot of people who had significant life problems as well as academic difficulties that lead to them not finishing school. They take a class here and another there and periodically have to drop out due to life reasons or even fail classes. Screwing up and not getting to a place where they can earn a comfortably livable wage and then continuing to earn 7-12 bucks an hour is pretty common. These folks then whine about how life is so hard and it isn't fair and generally have a long term pity party. What would often be a better course of action is to decrease their lifestyle if applicable, work less and borrow just enough to make up the difference. The difference between going to school and working 12-20 hours a week or 30-40 is huge. At minimum wage or close the amount of money we are talking about isn't that big. They could focus on school more and get it done at a decent pace. It probably will not be too hard to pay back said money with their increased future earnings. This is basically what I did and while I should have borrowed a bit less lived a bit cheaper it has worked out pretty well for us so far. End tangent.
With educational expenses should come degrees or certifications that significantly boost your earning power. I have got news for everybody. The days when a guy could graduate high school and fall into a comfortably paying job doing work trained monkeys could do are over. We could talk about why this has happened but it doesn't change that it has. Especially with today's economy and jobs being scare you need to be marketable.
Mortgages are slightly worse than educational expenses IMO. I say this is because they do not have the same kind of exponential payoff as education (if properly targeted and used). Also the returns are generally less of a sure thing. House prices have a great long term track record but the short-mid term can be wild.
It would take a really long time for most people to save the cash to buy a traditional home outright. There are certainly some benefits to alternative housing but if you don't want to go that way the options are saving a lot of money for a very long time or getting a mortgage. Certainly paying the landlords mortgage for decades instead of your own and not getting the tax benefits or the appreciation in value doesn't make any sort of sense.
Getting a decent fixed mortgage you can actually afford on a home makes good sense for somebody in a stable financial place with some savings. As you noticed that sentence was kind of complicated. Maybe adjustable rate type mortgages or other exotic options make sense for some smart people in some situations. However for most people they are a horrible decision. If you can't afford a fixed rate it means you can't afford the home. Stability is very important as even short mortgages last many years and you need to be able to make that payment every month. Personally I have seen a lot of people get into trouble when they happen to get a job that pays somewhat better than they can expect elsewhere, 10 dollar an hour type guy earning 13 or a job that pays 70k instead of 55. The issue comes when they get a loan they can afford at their current higher wages and for whatever reason (laid off, fired, decide to change fields, etc) they end up changing jobs. Think about how much you could make at another job. Also having a safety net in the form of an emergency fund is essential. You've got to be able to deal with that month the car breaks or being out of work for awhile. I think Chief Instructor said once that a month of looking for every ten thousand dollars in salary is a guideline.
Part of my concern is that the concept of "good debt" leads to an attitude that having this debt is normal and even smart. Yeah it smart to increase your earning power with a degree and eventually purchase a home. However it is really smart to pay off that student loan as fast as possible and in time the home too. Having a mortgage (for the right person) beats the heck out of renting but owning a home free and clear beats the heck out of having a mortgage. I think it is also worth noting that if you buy a modest home you can actually afford paying it off at an accelerated rate is probably realistic. If you get absolutely as much home as you can make the payments on of course it isn't realistic to pay 10, 20, 50 or even 100% extra principle payments.
Cars I would classify as the best or most understandable of the "bad debt". Buying cars with cash is ideal. However "clunkers" can have some real problems. Some folks are good at fixing cars or just lucky and others have horrible luck. Often clunkers are unreliable and just $400 the heck out of you until they die. Basically if you aren't able to save a decent bit of cash and need a car for transportation you're pretty much stuck getting a loan. The real problem is how expensive of a car you get. For example awhile back my little sister found herself needing a decent reliable car. She went and got a loan to pay for a few year old basic car. Not a junker but also not new or fancy or anything like that. She paid it off faster than the loans planned life and still drives it. You need reliable transportation, not a new Mercedes. Look at it this way. If you can't afford to pay cash it means you aren't in a great spot for getting this car so be reasonable.
Consumer loans and credit card debt and such are just bad. The best case is that you use these as a sort of emergency fund because you haven't saved a couple months worth of expenses. This is bad because if you can't afford this stuff now why would you think it will be easier to afford later. I am a realist and I know things happen. I can also note that for some strange reason things seem to happen a lot more to folks who do not have emergency funds. Some unforeseen stuff comes up that has to happen right away. Replacing a key household appliance is a good example. Lets say your washer goes out. You get a new one from Sears and finance it then pay it off over a couple paychecks. Not insane. [However what if something bigger happens. Putting a months worth of living expenses from some down time at work on a credit card could take forever to dig out of. ] However using consumer loans to get all new appliances you don't really need for the whole house is insane.
My observation is that people rarely get into consumer or credit card debt trouble because of using them to ride out an emergency. People get into trouble here by using credit to live beyond their means buying this and that and the other thing which they can't afford and almost certainly don't need.
Sometimes debt makes sense. It can be understandable and even a good decision. However do not forget that at the end of the day no matter how "good" debt is it's still a promise of money you haven't even earned yet. Use it responsibly and try to get out of it as quickly as possible.
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14 comments:
"The days when a guy could graduate high school and fall into a comfortably paying job doing work trained monkeys could do are over."
I take exception to that remark. Though it might not be a "sexy" job, plumbers, electricians, mechanics, carpenters, etc. are still very vital jobs, and require a high level of skill. That skill, as much as the "vocational institutes" would like us to believe, does not come from a classroom. It comes from experience. And I find that while society is dependent on those skills and experience, they are not willing to pay for them. They look down their noses at the very people who keep the lights on, the engines running, who build their fancy homes and cars, etc. etc. "Trained monkeys" (dammit how many times have I heard that) can't step in to a highly skilled position and take off running.
If you, as I think you are, are referring to assembly line workers and such, blame the greedy unions for their nefarious deeds, not the "trained monkeys" who work the line. It's not a pleasant job, I can assure you. And usually being a 24/7 operation, one must give up a lot of time with friends and family to work these jobs. That in itself merits a higher rate of pay than a lot of 9 to 5ers. Not to mention the hazards and health risks not borne by some desk jockey. There is a lot of training those "monkeys" must go through before they're allowed to set foot on a production floor, and a lot of continuing training beyond that.
No, you won't typically fall into a $40K per year job right out of high school, and nobody I know ever has. But I do know a lot of college grads who are standing in the unemployment line clutching their degree and student loan debt. College is not the be all end all. And "trained monkeys" deserve a lot more respect...
I generally agree, but I'm not quite so hard on all debt. I'd say if you look at your life as a business and make smart decisions, then debt can make sense. Why do businesses take on debt? Because they think they can grow their operations and their profits faster than the interest rate with that money. So you should do the same. If you take on student loans you can grow your earning power. If you own a small business taking out a loan for equipment might make sense. If you can get a steal of an interest rate and then reinvest those funds for a greater post-tax return, you're also making money.
Mayberry, I think that it is pretty clear that many of the first class of folks you highlighted are not "trained monkeys." They are skilled workers and often get some sort of certificate. However, I think that Ryan is pointing out that as the costs of automation decrease and the costs of hiring people increase, some of those jobs will be harder and harder to live on.
If you ran a factory, and a robot can replace 60% your staff for a prorated lifecycle cost of $20/hour, why would you pay a human more than that? If you were an auto mechanic, and using a computerized diagnostic allows you to do with one person in an hour what would have taken a team of people hours or days to do before (tear down an engine), are you going to invest in a computerized diagnostic machine or hire a bunch of people? I even know small independents that are using these technologies and slashing staff.
Saying that "someone has a really hard job so they deserve to get paid more" is kind of like the Labor Theory of value... Would you be willing to pay double the price for a product that was assembled in twice the time but is the same quality as a cheaper, easier to produce product?
Mayberry, Maybe I wasn't clear. I was talking about low skill manufacturing type jobs. A guy who puts bolt #92 on something or the like. I said degree or certification but skill would have worked well in there also.
As for pay that various jobs get. We live in a generally free market and it sets wages. There are a lot of people who can put bolt #92 onto the thing but not many who could do brain surgery. Thus after unions are marginalized or worked around the wage for Bolt #92 guy is relatively low. A lot fewer people can say manage a hedge fund or perform brain surgery so those folks make lots of money.
As for the college versus skilled labor. The stats overwhelmingly show college graduates earn more than non college graduates. However if non college grads were divided; say into into skilled (journeyman type electricians, plumbers, carpenters, etc) versus low skill and service the story might be different. A skilled and properly certified diesel mechanic can make a fine living. Plumbers do well also.
Oh yeah, I have nothing against people who perform these jobs we are talking about. It's just that I have no sympathy if they are unhappy with their wages.
Ryan, I'm not saying pay the guy "putting in bolt 92" should earn $30 an hour, but I am saying that the guy deserves a bit extra in exchange for working wierd hours, many times at odds with his circadian rhythm. This is not without detrimental effects...
There you go with the "properly certified" mindset that has destroyed the trades, and driven labor costs through the roof. The stats can say what they like, and those stats are driven by acedemics who, for their own selfish reasons, wish to make every occupation require some over priced piece of paper. There used to be a thing called an apprenticeship, which resulted in OJT and eventual journeyman status, which equalled decent pay. Rising to the master craftsman level then provided excellent earnings. Not so anymore because the public has become accustomed to buying disposable crap, no thanks to moronic government interlopers and their idiotic, destructive policies...
Chris, have you wondered why all that labor has been displaced? It's because the deck has been stacked in favor of the machines by insane government policy and laws. "If someone has a really hard job they deserve to get paid more" is right. Are you willing to bust your butt for peanuts? I know I'm not, because the effort expended is not worth the return.
Chris, I think debt is bad. If memory serves me correctly debt is one of the biggest reasons small businesses fail. Of course if you can borrow money at 2% and put it in a CD or high interest savings account at 6% it is an easy way to make a few bucks. However if you borrow at 2% and put it into stocks and they go down you still have to repay the loan.
Sometimes debt can work out for you but if possible it is best to try and not borrow money.
Mayberry, I am confused. You talk about how government policies and unions are hurting Mr Bolt #92. I can get that. Prior to unionization generally these sorts of jobs got poor to OK wages. Unions came in and with eventual government collaboration got Mr. Bolt #92's wages up to $30 an hour.
You then talk about how he "deserves" more pay because the job has some unpleasant parts. That sort of touchy feely pseudo classist stuff is strait from union talking points. Also it almost directly conflicts with the first point.
The reason machines are taking over is that the initial investment in them is cheaper than paying people over the long run. The owner of the warehouse realizes he can save 200k a year and break even on the initial investment in 10 years if he switches to machines. Usually wage increases because the workers have a hard job and deserve a little more are the impetus for this switch.
There are still apprenticeships. As for certification I would like to know the guy who is going to fix the brakes on my car or works on the gas pipe knows what he is doing.
Ryan, your point was that "trained bolt monkey" should get slave wages. They do not get slave wages, because the job sucks, and therefore labor demands higher wages. Nobody will do it for slave wages. If that's "touchy feely pseudo classist stuff" well then I guess it is, but it's still a fact of life. Let's say, as I've heard a hundred times over, that "there's 100 trained monkeys waiting to take your job", so they're cutting your pay by 1/3. Would you still be willing to do your job for 1/3 less? I doubt it. Because I know you do stuff that is certainly unpleasant, and that's in the "good" times. Think about that one, particularly from your "E" days...
I still think there is an argument for good debt.
Let’s look at this example: I buy a home 100% financed for $100,000 in today’s dollars ($324,339.80 in 2040 dollars @ 4% annual inflation). It cost me $5,000 in closing costs out of pocket. They payment is $811.14 for 30 years @ 7% interest (investment properties have higher interest rates). The payment includes 1.25% for property tax and a 0.05% PMI. I rent the property for $1,000 a month. That is a positive cash flow of $188.86. I didn’t include insurance because it is hard to estimate in investment properties, but it is pretty cheap since you are only insuring the property. I am going to assume that there is still money leftover each month after paying insurance.
Now let’s throw some wrenches into the scenario. All of the positive money over the years was put back into the property for repairs etc. so the property made $0 over the 30 years, so we are looking at $67,989.60 years spent on insurance and upkeep. Also, in 2040 a near TETOWAWKI situation happens to the housing market and the home value drops 75% or down to $81,084.94 in 2040 dollars ($25,000 in 2010 dollars). That $5,000 I invested in the property at the beginning is worth $16,216.99 in 2040 dollars. If I sell the property my net gain would be $64,867.95 ($20,000 in 2010 dollars). So my $5,000 dollars turned into $20,000 over thirty years, which is just under 9%. Now the interest on that mortgage never mattered because the renters paid it not me. Even with the cost of repairs and bad luck in the housing market I made money. Anyone feel free to chime in if my math is wrong, I am a little rusty with present/future value calculations.
This is one of the few areas I consider good debt. Rule of thumb for good debt: If you are not paying the interest it is good debt.
Bryan, What about your liability though. Lets throw in another realistic problem. What if it doesn't rent out for awhile. What if some lowlife comes in and doesn't pay the rent. Those are the sorts of folks who know the system and it takes months to get them out. So YOU are paying the mortgage.
Mayberry, My original point is that people should get skills/ a certification/ degrees to be able to earn a decent wage. As for wages they are set by the free market. How many people are capable of doing a job as well as its unpleasantness are both factors. Working at McDonalds sucks and it doesn't pay well largely because just about anyone can do it. Strait up manual labor (digging ditches, etc) sucks but anybody with a strong back can do it so the wages are low.
Ryan,
I agree no debt is best, but I think a mortgage isn’t that bad, especially the 15 year loans. Pay the bank instead of rent, and it’s an awesome tax break. We sold our place last year to be free to move, and losing the tax benefit has been a bummer.
Also agree on the education thing. I used the GI Bill through all of undergrad and most of grad school. If you’re going to grad school full time, many schools will throw scholarships and grant money at you. I did incur a small amount of debt during a year studying abroad, paid off years ago. Seven years after finishing grad school, and adjusted for inflation, I’m making a bit over twice was I was making prior to school and have very secure job. With a technical degree I’d probably be doing better with more mobility options, but I can’t really complain. As long as the degree is useful, it’s well worth it. Including a little debt.
Mayberry,
Those trades are for the most part considered skilled labor, I think. Takes some time/training to get to journeyman. After the Army, my dad became a carpenter. Now he builds Wal-Marts and similar structures. Myself, via the Air Force (many years ago, before college) went the tech school and OJT route to my journeyman status in comms (tech side). Sometimes I wish I’d stayed on that path.
I'm still not convinced that debt is so horrible. I didn't do the college thing but I did end up being pretty good in a field that most people require a degree for. I knew some people and proved myself. Now I'm not worried about finding a job if I lose this one. Then again I'm not worried about losing this one. With that being said college is a great investment that can open doors and turn out to be a great stepping stone. It depends on the person, though.
If I had it to do over again I'd have kept renting a cheap apartment for a couple more years until I could afford to pay cash for a townhouse or condo. Then I would have scrimped, saved and invested until I could afford to either pay cash or put enough down on a real house that the payment would be extremely easy to make. I bought into the whole "you can't lose with real estate" around the peak of the bubble, though. Oh well. I did buy less than what I could afford and I'm making more now than I did then. It's still going to take me a whole lot of years to pay this thing off.
Cars are horrible investments. I bought one new. It's the last new car that I'll ever buy. I've owned a dozen or so "clunkers" and even with my limited mechanical ability I've always been able to keep them going without spending much. Usually, if I'd ever get stuck with a $400 repair I'd just find a new car.
Credit cards are dangerous. You can't just charge them up then pay the minimum payment every month. If you're responsible they can pay off, though. First of all they can improve your credit a great deal. You also get a lot of perks from using them. You just have to carry a small balance or pay them off every month. Then there's the "emergency fund" aspect. As long as you don't get in the habit of living off of them and you don't carry a crushing balance then there's nothing wrong with them. It's just really easy to get carried away.
Perhaps a better way to look the problem is a level of debt based on projections. Now I have a home I make payment of $526 per month. Now I can't rent a much cheaper home and every month I put at least $67.00 dollars on retiring that debt.
Now, I do agree a house free and clear is better than a house that is Mortgaged to the hilt.
Have I used my equity? yes. did I go crazy when the brokers said I had so much equity I could borrow against, no. I knew what I could afford as payments each month. I won't default because I have an emergency fund for deflation and I'll pay off my loan in hyper-inflation.
So I think there is good debt. A layaway program is good debt, though a Macy's credit card is bad debt usually.
I'd like to blame the banks and credit card companies but I can't. You screwed the pooch and got caught,you wanted free ride on stuff and it's time to pay. So if I have to pay so do you. But maybe you have an Obama or Timmy Gietner attitude. You don't have to pay unless caught. I want to know what politicians you vote for?
I am sure your folks are so proud!
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