Debt is a loaded topic in financial planning. When is it good or bad, and what’s the best way to approach it?

There are two main things to consider:

What’s “financially optimal” and what feels right given your own unique circumstances. 

Not all debt is created equal. Clearly, high-interest credit card debt is “bad” and should be avoided if it can be. But what if you need to carry a balance for a certain amount of time because life requires it? Take a home mortgage, for example: With it, you can still grow other investments at a faster rate. However, what if getting rid of your monthly mortgage payment is really important to you?  Seeing where debt fits into the bigger picture of your financial plan can help you make decisions — like paying it off now or saving that extra cash — as purposefully as possible. 

Following the home mortgage example, sometimes we have clients who feel strongly about taking out a 15-year mortgage on their home. To them, a 30-year mortgage feels like committing to 30 years of debt —  a reasonable feeling to have! However, payments are higher when you have a 15-year mortgage versus a 30-year; if our clients choose a 15-year mortgage, they’re locked into a higher monthly payment for 15 years, with no wiggle room. In those cases, we’ve reminded our clients that you can always treat a 30-year mortgage like a 15-year, but never vice versa. In other words, you can always get a 30-year mortgage and simply make higher payments so that it’s paid off in 15 years (or even less, up to you!). All the while, you always have the flexibility to reduce your monthly payments if something happens and you need the extra cash flow.

The emotional component. 

Maybe you can tell that strong emotions run beneath the example above. And those emotions don’t come from nowhere. We all grew up hearing different messages about debt from our families, friends, and voices in the media. Maybe you grew up in a culture that viewed any sort of debt as bad. You may know stories of people who ran into hard times because of debt. Financial guru, Dave Ramsey, urges his many followers, with the religious fervor of a preacher, to avoid debt at all costs, after experiencing his own downfall earlier in his life. 

You may also know of people who’ve used debt as a tool to significantly grow their wealth. They’ve invested in real estate (like flipping houses) or taken out “margin loans” (taking out a loan to invest in stocks). Even though this is a different way to see debt, I would still advise against either strategy because it’s really risky. And I would refer right back to my Dave Ramsey example, because that’s also exactly how he met financial ruin!

A more familiar example comes from when I recently spoke with a friend who has student loans and a car loan. His car loan is currently financed at 0% interest — long enough for him to pay it off in full before ever having to pay a dime in interest. He makes enough money from his job to cover the bills and then some. This year, he’ll probably get a bonus from work that will be close to the remaining amount of the car loan. He said that — even though he knows it would be smarter to pay off a chunk of the student loans that are accruing interest — he’d much rather pay off the car to simplify his life. He doesn’t want the car payment, and he’s okay with the student loan payment being long-term.  In this case, my friend is prioritizing the emotional component in paying down debt. And that’s fine with him, because he knows that his long-term financial plan will be secure either way.

After considering those two things — the tension between what’s “optimal” and what’s right for you, and the emotional component of your financial decisions — I’d say debt is more personal  than it is good or bad. It’s always important to seek out trustworthy information on how to make healthy financial decisions around debt. But I would argue that it’s just as important to understand the feelings and emotions you have about debt. In what ways do you see debt as good or bad? How extreme are your opinions about debt, and where do they come from? How might your feelings about debt inhibit you from (or support you in) making healthy financial decisions? 

You can find ways to financially optimize decisions about debt and even leverage it (no pun intended) to make yourself wealthier. Obviously, you need to stay informed about the consequences of any financial action. Looking at the risk involved in taking out a loan on an investment property is important to determine if it’s really a good idea. If you choose to pay off a loan ahead of schedule, you’ll need to understand how much your savings could be negatively impacted. Along with the more concrete considerations are the strong feelings you have about debt. They can show you that even though your decision isn’t the most “financially optimal,” it’s still the right one for you. 

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