Good Debt

Not all debt is bad. Sometimes debt can be good. I use “good debt” to help me in” times of emergency or when my investments are doing well and I prefer not to sell them to pay for large purchases (for example, a vacation, a new air conditioner, etc.).

When is debt good? There are three characteristics of good debt:

1. You control the amount and timing of principal payback.

2. The interest rate and/or fees are lower than the current rate you are paying.

3. There is a minimum 12-month payback period. In this way, you can spread your payments out over 12 periods.

Where can you find good debt? If you have a de-cent credit rating, you probably receive good debt offers in your mail box at least once a week. Credit card companies and banks are constantly issuing “checks” that you can use to payoff existing debt or add a cash deposit to your bank account.

Let’s say you want to do some remodeling that will cost $10,000. You could cash in some of your financial holdings, but you’d rather leave the money invested as you are receiving a good rate of return. A bank sends you checks with the following pro-motional offer: (1) you can borrow up to $15,000 at 1.99% annual interest with a payoff date of June 1,2018, or (2) you can borrow up to $15,000 at 0% interest for a 3 % fee with a payoff date of February 1,2018. Since you are borrowing the money for longer than a year (15 months), your effective rate under option two is 2.4% [(.03/15) X 12].

Assume you decide to borrow $10,000. It is important to completely payoff the debt by the above date-June 1, 2018 for option one, and Feb. 1, 2018, for option two. If you do not, whatever amount remains unpaid is subject to an APR of 22.24% under either option.

To assure your account is zero by that date, it is best to make systematic monthly payments. For example, if you select the second option, your total payment is $10,000 plus the $300 fee, or $10,300. To avoid any interest charges, you must payoff this amount before Feb. 1, 2018. If the bank check is dated Nov. 1, you will receive 14 monthly bills before final payment is due. By paying $736 per statement ($10,300/14), the loan will be paid off before the final due date.

A word of caution: carefully read the terms of the agreement. It makes sense to borrow only if you are receiving a higher return on your investments than on the fees and interest associated with the debt. Additionally, once you’ve accepted the offer, do not use the credit card again until the loan is paid off. If you do, your new purchases are last in the payoff queue and will be charged interest, as in the example above, of 22.4% until the original loan is paid off.