Good Debt, Bad Debt: The 5 Best Reasons to Borrow

By John Persinos
October 27, 2010

There's been a lot of debate lately about our nation's debt level and its burden on future generations. And as one asset bubble after another has popped, leaving behind only the mountains of the debt we accumulated to buy into those bubbles, we're slowly but surely being conditioned to think that all debt is bad.

So brace yourself for a bit of modern-day heresy: Some debt is good.

It's certainly true that too much of the wrong kind of debt is severely debilitating -- and should be avoided. But there are circumstances when the right kind of debt, used properly, can be exploited to your long-term advantage. In fact, in certain situations, I could argue it's irresponsible NOT to incur some debt.

Individuals can use debt to invest in their future income, increase their net worth and build an asset base to use in retirement. The trick is to only borrow for things that can appreciate in value.

I've put together a list of my 5 favorite investments that should be bought with at least some debt. Here they are, in no particular order:

1) A Place to Live

Look past the scars of the recent (and still unfolding) housing meltdown. Sure, the days of using your home as a de facto ATM are over. But buying a home still makes sense. It's supposed to work this way, and it still can: you buy a home, work patiently to pay off the mortgage, and then eventually enjoy owning and living in a mortgage-free dwelling.

[If you're ready to buy a home, use our Mortgage Calculator to see what your monthly principal and interest payment will be.]

In the meantime, you can take advantage of the mortgage interest deduction on your taxes -- one of the few significant IRS breaks available to the middle class.

Despite the periodic noises on Capitol Hill about eliminating the mortgage interest deduction, don't believe it for a second. The realtor, mortgage and home building industries employ armies of powerful lobbyists that would never let it happen. It would be like repealing baseball and apple pie. And once you're able to qualify for this all-American tax break, it opens the door to other forms of itemization on your tax form.

2) Investment Properties

If you're of relatively modest means but still want to invest in tangible real estate, your best bet is to buy a second home and become a landlord. As a landlord, you're able to build equity in a house and enjoy the tax benefits of the mortgage interest deduction -- but your renter is making the monthly payments for you.

You also can deduct on your taxes any home improvements or money spent as a landlord. It's a sweet situation. The keys are to a) not overpay for a property, and b) carefully screen prospective renters. You'll want to find responsible tenants who'll serve as guardians of your investment.

Individual investors can also buy commercial real estate as a long-term investment. Even if you're not a big institutional investor like a real estate investment trust (REIT) research and guidance, you can take advantage of powerful strategies when looking for a target. For example, click here to learn The Secret to Successful Real Estate Investing: Triple Net Leases.

3) Education

Even after accumulating all the scholarships, grants or family gifts you can get your hands on, you'll probably end up borrowing at least a portion of the high (and rising) cost of college tuition.

Whether you're borrowing for your kids' education or your own, college can seem prohibitively expensive. And sometimes it is. But it still counts as one of the best possible investments you can make for your children's future or your own. A worthwhile college experience should provide both tangible and intangible resources for a future career, and should also help hone marketable skills valuable in a global economy.

Studies confirm the obv with college educations make considerably more money over their lifetimes than those without.  And if you're seeking a mid-life career change and want to obtain a Master's degree or doctorate, the additional debt is almost always a worthwhile investment in your personal growth and future earning potential.

4) Certain Home Improvements

Home improvements generally fall under two categories: logical and ludicrous. Adding value isn't always as obvious as it seems, and spending money on improvements that won't pay off in the long term is not smart. But if you stick with projects that are likely to pay you back in the form of a higher sales price, borrowing to complete them can be a good investment.

The litmus test is whether the improvement will make the eventual buyer of your home happy -- not how you feel about it.  I recently wrote about the Nine Things You Think Add Value But Don't, so check it out before you commit to adding that in-ground pool.

5) A Cash Management Tool

Back in the heyday of the housing bubble, when average homeowners took out home equity loans they generally squandered the money on cars, boats, vacations, flat screen televisions, etc. That's what I refer to as BAD debt. But if managed properly, a home equity loan can enhance your wealth building goals.

Take a cue from small, well-managed businesses that borrow for short- or intermediate-term purposes -- but then make a point of paying off that borrowing in a pre-determined timeframe. If used for targeted purposes, a home equity line can serve the same purposes as a line of credit taken out by a small company. You can use it to retire higher-interest debt, free up cash flow, etc. Just don't use the money to take your wife to Maui.

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As I mentioned at the top of this article, our huge national debt is on everyone's mind. Having a hard time putting it into context? Check out an article that should be a must-read for every voter: A Stack of 1 Trillion Pennies: 5 Ways to Visualize Our $13 Trillion National Debt.