Good Debt, Bad Debt

My parents never shook the dust of the Great Depression from their world view. I can’t begin to count the number of times I heard one of them say, “You never know when there will be hard times.” As “gatherers,” I remember being sent up on the roof of the parsonage to pick apples off of the neighbor’s tree (with permission) and gleaning in the strawberry field the night before it was to be plowed. In their later years when they dictated their annual Christmas letter to me, they often began by counting the quarts of green beans or jars of blackberry jam.

Mom and Dad were in their teenage years when the Great Depression hit northern Oklahoma and southern Kansas. Life was tough even before the dust storms blew dreams away. We found a yellowed photo of Mom with a cat wearing a black ribbon. The cat was in mourning, she told us, because its mother had died. Then she muttered, “I hate that picture.” Totally surprised by her pronouncement, we asked for an explanation. “My toes are hanging out!” We examined the photo closely and, sure enough, we could see that her left shoe was falling apart.

I’ve looked at photos of my paternal grandfather proudly perched on a combine in an Oklahoma wheat field. He owned the first combine in the Burlington area. Twelve horses were needed to pull it through the fields. When the Depression hit, however, he lost the combine and left the homestead. The imprint of those early experiences shaped my parents’ decisions over the next 75 years.

During the Great Depression when unemployment was a major problem, people dipped into their savings, if they had any, to provide shelter and food for their families. This resulted in what economists refer to as a negative savings rate—people spent more than their income. In the last 74 years, there have been only four years with a negative savings rate: 1932, 1933, 2005, and 2006. That got my attention! Figures like that seemed like a thing of the past!

The U.S. Commerce Department reported that for 2006 the savings rate was a negative 1 percent (Feb. 1, 2007). The savings rate is calculated by subtracting spending from personal income (after taxes). Since the figure is negative, it means that in 2006 people either took money from savings or used credit to make the purchases. I suspect that the negative savings rate is due primarily to increased debt. The Federal Reserve reported that for 2006 the balance of consumer debt increased 4.6% to $2.4 trillion (Feb. 7, 2007). Statistics like these point to an increasing danger for the United States and the families who are financially overextended.

While some preach a total debt abstinence, I distinguish between “good” debt and “bad” debt. Good debt might finance a house or an education or a business, all of which have the likelihood of increased value or earning potential. Bad debt chases anything that loses value, like a car or furnishings, or is consumed, like a vacation or Christmas presents. Bad debt should be avoided; good debt may be considered.

To assess your debt load, make a list of everything you owe. Group the items into “good” and “bad” debt. Next to each debt on your list, write the remaining balance, the monthly payment, and the interest rate. Place the sum of all balances and payments at the bottom. Take a good look at this snapshot to begin developing a strategy to reduce your debt.

Start with the “bad” debt section. Select either the debt with the lowest balance or the highest interest rate as your first target for additional payments. Devote as much cash flow as you can to speed the elimination of that debt while making minimum payments on the other accounts. Once one “bad” debt account is closed, add the amount you have been paying on that debt to what you’ve been paying on another debt from the list to accelerate your journey to financial freedom. Repeat this strategy until you exorcise all “bad” debt.

Then make the commitment that if you must increase your debt load, it will be of the “good” variety. Add something to a savings or investment account every month, even if just a few dollars. You’ll not only create greater financial security for your family, but will contribute to a healthier economy too.

Originally published by Pensions & Benefits USA.