There’s a clear line when people talk about debt – there’s the good kind and the bad kind. When you borrow $800,000 to buy a million-dollar home in Vancouver, people congratulate you and throw you a housewarming party. On the other hand, wrack up $8000 in credit card debt and people are standing in line to boo and hiss.
God knows I’ve fallen victim to this “good debt” trap more than once. That MacBook is looking especially shiny this week….
The point is that it’s easy to dismiss payments and interest when your purchase falls into the “good debt” category. It’s like those words magically open our wallets in a way few other things do. Check out the examples below and ask yourself if they apply to you. I know both did for me. I bit off waaaaay more than I could chew.
Are Student Loans Worth It?
Yeah, you get the idea. While this might be a slight (not really) exaggeration, some of my other “good debt” buying decisions have cost me a lot more than a few thousand dollars. I graduated from University with a B.A. in Psychology and $50,000 in student loan debt. There were extenuating circumstances, of course. I was a single mother trying to go to school full-time and raise a child and that usually takes more cash.
But that’s the issue, there are always extenuating circumstances, aren’t there? So how do you determine when you’re heading for a good debt trap? The general rule of thumb for college is to avoid borrowing more than your first year’s salary after graduation. According to a 2013 Forbes survey, 57 per cent of students didn’t go with their first school choice largely because of cost.
If you do feel that you must choose the more expensive school because it’s got great connections with Silicon Valley or you plan on pursuing graduate studies there, work as hard as you can to get the most of it and land that dream job afterwards. Money may not be everything but it’s sure a big part of it so choose wisely.
I did pay off the debt but it was a crazy amount of work. In hindsight, I think I would have tried to do it differently.
A Mortgage Has Gotta Be Good Debt, right?
Buying a home is usually a good investment but there are going to be exceptions to the rule. Here, the cost of the home isn’t as important as your debt to asset ratio. Royal Bank uses a couple of different ratio equations to determine if you’re a good candidate for a mortgage.
There’s the Gross Debt Service (GDS) that determines how much of your gross (before taxes) annual income will be going towards paying your mortgage. Most lenders will stipulate that you spend no more than 31 to 32 per cent of your gross annual income on housing costs – mortgage payment, property taxes and heating costs (and condo fees for those in a unit).
Then there is your Total Debt Service (TDS) Ratio. This measures how much of your gross annual income goes towards all debt payments. So, they will factor in your student loans, line of credit, car payments and any other loan products you may have.
Most lenders say that these bills can’t exceed 37% of your gross annual salary. I’d say scale that down to 30 per cent if you can. If that’s unrealistic, try and keep that ratio as low as possible. Use a calculator to help you figure out your numbers because 37 per cent debt is a lot to spend when you’ve got a family to raise, a house to maintain, and a life to lead. I know it was for us.
Just because the banks says “Yay! Here’s some cash” doesn’t mean it’s the right decision for you. Check it out in action…
The really important take away is to examine all the sides before taking on a big financial commitment. Hell, even do it with smaller ones. It’s good practice and all those little things can add up into a big thing. Like that Visa bill or that store credit card. Either way, weighing all your options – including the ones you don’t want to think about – is the best way around it.