So, let’s talk about debt

If you live in America, you probably have debt. That’s basically just the way it is, so debt is probably going to be one of the major topics I talk about for the REST OF TIME. Happily, there’s quite a lot to say about it, so that’s not a bad thing.

First of all, for people who have long dwelt under rocks, what is debt? Debt means borrowing money from someone (usually a bank or another financial services institution) to pay for something that, typically, you can’t afford to pay for in cash. For example, if you want to buy a house, you probably don’t have the ability to pay for it with cash, so you borrow money from a bank.

You can think of debt as being divided into “good” debt, and “bad” debt (honestly, almost all debt is bad, but hear me out).

Good debts

 Student loan debt can be good or bad.  Photo credit:  LendingMemo  /  Creative Commons Attribution 2.0 Generic (CC BY 2.0)

Student loan debt can be good or bad.

Photo credit: LendingMemo / Creative Commons Attribution 2.0 Generic (CC BY 2.0)

Good debt includes some mortgages and some student debt. This kind of debt is sort of bad, because you end up paying more for your home or degree than you would have if you had paid in cash, obviously. However, it’s also good, because you end up with something that (hopefully) is more valuable than what you paid for it.

If you’re lucky, your house will increase in value more than what you spent on it, and your degree will increase your earnings by more than you paid for your degree (interest included). In other words, you’ll make money on this debt, which makes it good.

Of course as people have learned, especially in the last few years, this isn’t always how it goes. Many people have purchased houses and ended up losing money on them; if you tally up everything you pay, including interest, taxes, repairs, and improvements, your house costs WAY more than the sticker price, and quite often when people sell their home, they actually don’t recoup their costs. Similarly, many people, particularly those who have paid for costly graduate degrees, find that their earnings actually don’t increase more than the cost of the degree (I will rant about this a LOT, so prepare yourself). So, some mortgages and student loans are actually bad debts.

 Cats need luxury sofas, rights?

Cats need luxury sofas, rights?

Bad debts

This is the kind of debt where you pay a lot more for the thing you bought than you would have if you’d paid cash, and don’t reap benefits equal to that value. Credit card debt is a classic case of bad debtness – when you buy something on your credit card, and don’t pay the full balance at the end of the month, it’s going to cost you and you’re almost certainly not going to reap any benefits. Let’s work through an example, starting with a bunch of assumptions. Say you buy a kitty castle for $1000 on your credit card (cats need toys, yo!). And say you only pay the minimum on your balance. And say your credit card has an APR of 18%. And say you pay the minimum balance, which is usually 2%. What are you going to pay for Captain Bonkers’ cat palace?



Very roughly, this is how you work it out:

1.      2% of your starting balance (of $1000) = $20

2.      Interest for the month:

a.       18%/365 days = 0.49%

b.      0.49% times 30 days (in a month) = 1.48%

c.       1.48% times your balance = $14.90

3.      What you pay towards interest: $14.90

4.      What you’ve paid towards the cat tower: $20 minus $14.90 = $5.10

5.      What you still owe on the cat palace after paying $20 = $994.90

If you keep plodding away at the math (or if you use these handy dandy online calculators) you’ll work out that it will take you 150 months (or twelve and a half years) to pay off your cat palace, and it will cost you $2,396.70. At the end of that period, you will be able to sell your cat palace for no dollars, because Captain Bonkers will have destroyed it within eight minutes of you placing it in the living room. This is the definition of a bad debt.

Auto loans are often also bad debt – you pay more for your car than you would if you’d paid cash, and then you sell it for way less than you paid for it. I mean, I know that some cars do appreciate in value, but let’s be honest, your 2009 Honda Civic that you hit the curb with is not headed to Sotheby’s. It’s true that owning a car saves you on public transit costs, if you’re lucky enough to have access to those options, and that for most Americans a car is a necessity. But auto loans are usually bad debt, so you really have to be smart when you buy a car. We’ll spend some time on this subject in the future.

What have we learned?

Probably you haven’t learned that much, but maybe? Hopefully, you now have an idea of how to think about debt – think about what you’re actually going to end up paying, think about what the value is of what you’re getting for your money, and ask yourself if you’re getting value. If not, avoid it.

P.S. We will talk about avoiding and dealing with debt, never fear.