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Good Debt and Bad Debt

Debt is a loaded word - never a borrower nor a lender be - most of us have heard this phrase. Yet, if you look at various banks - even during the current subprime crisis, they seem to be doing just fine - clearly we are getting mixed messages.
Fortunately, the subject of debt is very simple - there is good debt, there is speculative debt, and bad debt.
If you have to pay the debt out of your own pocket - it is bad debt.
If someone else is paying down your debt - it is good debt.

It is very difficult to achieve wealth if you have bad debt - bad debt means sharing your wealth with banks, credit card companies, loan brokers - and not getting any assets in return. Here are a few examples of good, speculative and bad debt.

Examples of good debt:
* Fixed rate credit card debt invested in bonds - if you had an offer to borrow $10,000 at a fixed rate of 3% until paid off, and you took the $10,000 and invested it in a bond that pays 7% - this is good debt.
* If you bought a duplex, borrowing most of the money, and have a positive cashflow - then tenants are paying down your debt - it is good debt.
* If you bought a small shopping mall with only 10 % down, upgraded the tenants, and now not only have positive cashflow, but can also sell the mall at a profit - it is good debt.

If someone else is paying down your debt, and once it is paid off, you end up with a valuable asset or cash - it is good debt.

Examples of speculative debt:
* borrowing to buy gold
* borrowing to buy growth stocks
* borrowing to buy undeveloped land
* borrowing to buy a vacation home

In these examples, you have to pay down the debt by yourself, but at least there is a chance that what you bought will appreciate in time.

Examples of bad debt:
* borrowing to buy a car that costs more than $15,000 ( most of us need to drive, but a $15,000 Honda gets you there just as fast as a $45,000 Lexus)
* borrowing to buy a plasma TV
* borrowing to buy toys ( both for children and adults)

Incurring debt for any of the above items is a financial mistake. If you cannot pay cash - do not buy it. These items do not increase in value over time nor do they generate cash flow - therefore you should not borrow money to acquire them.

This pretty much covers the subject of debt. Get debt that others pay off for you, avoid debt that you have to pay down yourself. If you stick to these guidelines, debt will work for you, not against you.

Next week, we will talk in details about debt elimination strategies.




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