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Ask The Financial Expert: When Is It Good To Take On Debt?

Ron Joelson •  June 2, 2015 | Your Finances, Ask the Expert

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When is it good to take on debt—and is there good debt, is there bad debt?

Our Experts: Ron Joelson and John Mroz

John: Absolutely. I look at good debt as borrowing for things you need and in a situation where you can actually get a return on your investment. That means you can actually make more money by taking out a loan. A great example is student loan debt. The Federal Reserve Bank of San Francisco put out a report a couple years back saying the average earning power for someone with a college degree versus someone with just a high school diploma is about a million dollars more over his or her adult lifetime. So borrowing money to pay for a college education can be a big advantage in the long run.

Another type of good debt could be taking out a mortgage. If you’re a renter, and you’re paying that rent month after month and year after year but you’re not gaining any equity ownership, taking out a mortgage can be beneficial in two ways. First, you’re gaining equity ownership. So you’re getting a return on that money you’re borrowing. Second, that mortgage debt can be tax deductible. So at year-end when you’re doing your taxes for the previous year, you’re actually gaining a little bit of an advantage from having borrowed money to buy that house.

On the other side, there’s definitely bad debt. Bad debt is going to be borrowing money to buy something that you want or to buy something that’s more expensive than you would have been able to afford otherwise. Some of the main culprits are going to be your furniture and appliance stores. Every holiday weekend, they're running a sale, they're extending some sort of great credit plan; but in reality it’s just encouraging consumers to borrow money to buy something that they couldn’t afford otherwise. And you are paying the interest, which means you are going to end up paying even more over time. That’s where we’re seeing a lot of consumers getting themselves into trouble: borrowing money, whether it be on a credit card or with some of these “no payments for six months” deals and ending up paying interest for years and years at sometimes very high rates.

Student loan debt certainly seems like good debt, but there is so much of it out there. Should we be concerned about it from a broad perspective?

Ron: First of all, you’re quite right, there is a lot of student loan debt, and too much of anything is probably a bad thing—even the good debt. And the student loan debt right now is $1.2 trillion. The scary part is that about 11 percent of student loan debt is 90 days delinquent or in default, the largest category of consumer borrowing (such as autos, credit card debt, etc.). In fact, every class of consumer debt has been declining steadily since 2003, with the exception of student loans, which have been increasing. And a lot of it has to do with the cost of education, which has been skyrocketing; the overall level of rates, which has been low and therefore attractive; and a willingness of lenders to lend.

One of my concerns is that the average pre-crisis loan was a little bit over $17,000. Today the average student loan debt is nearly $30,000. And it’s having an economic effect, too. We’ve talked previously about what’s going on with personal consumption and household formation, and student loan debt is delaying household formation, I think. We can’t prove that that’s the linkage, but if you think about it, the rate of homeownership is about 36 percent less among people who make between $25,000 and $50,000 a year and still have student debt. So if students are delaying car and home purchases, that's probably a bad thing.

The share of heads of households under 35 who own debt is 40 percent. And one in five households overall have student debt. So it is becoming a burden; and while debt can be very positive in the economy and we can talk about overall leverage if you like, this particular area seems to be getting in the category of pretty excessive.

Hear more from Ron and John in the “Ask the Financial Expert” podcast, moderated by Mark McLennon, Northwestern Mutual’s vice president of investment product development.

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