Describe the three characteristics of good debt and why good debt is difficult to measure.

Question

What will be an ideal response?

Answer 1

Good debt has three common characteristics. The asset or the thing you purchased with the debt should (1) appreciate in value, (2) last longer than the term of the loan, and (3) provide positive financial leverage. All three characteristics must be present, not just one or two, for the debt to be considered good debt. In order for debt to be good, the thing that you finance with the debt should be something that appreciates in value. A house, for example, is something that historically rises in value. Also, the asset should last longer than the loan. Again, you expect your house to last longer than the loan, even a 30-year mortgage. Finally, the value you get from the asset should be more than the total cost to acquire the asset. Finance people have a fancy finance term for this. It's called positive financial leverage. Although this is a fairly simple concept, it can be very difficult to measure. Again, most people agree that borrowing money to buy a home is good debt. In addition, you don't always borrow money or incur debt to buy tangible products. For instance, are student loans considered good debt? In most cases yes, but it really depends on your situation. You expect any education to last longer than a student loan, and a college degree should lead to a better job and a better life than would otherwise be available without a degree. In most cases getting an education is a great investment. However, if someone borrows money to attend college, but never completes their degree, rule number three is broken. It is difficult to leverage a partial college education to get a substantially better job without a diploma in hand.