We're sometimes asked whether some debt is OK. People wonder whether it's best to not have a mortgage or student loan debt. The answer is that not all debt is alike -- and not all debt is bad. It's very reasonable to carry a mortgage or a car loan, for example. You simply need to pay attention to the cost of the debt. If you're carrying revolving debt on a credit card that's charging you 18% per year, you're in a bad situation. If your student loan is costing you 6% per year, that's much less worrisome.
Another consideration is what else you might do with the money you'd use to pay off a low-interest loan. Imagine that you've borrowed $5,000 at 6% and you now have the money to pay it off in full. You could do so, but consider the alternative. If you're bullish about a stock or two and are fairly sure that, over the next five years or so, you'll earn at least 15% on them per year, on average, then you might choose to keep the loan and pay it off gradually, as you originally planned. You might take the $5,000 and invest it. If the stocks perform as expected, you'll be earning more than you're paying out in interest.
That's why mortgages, for example, are not necessarily a bad thing. If your mortgage rate is low, it makes perfect sense to keep paying it off gradually. (If your rate is high, consider refinancing it, if you can!) Mortgage interest brings with it some tax benefits, too. (Find great tips on buying and selling homes by checking out our Home Center, which also features some special mortgage rates.)
Along the same lines, as investors we shouldn't assume that any debt on a company's balance sheet is a bad thing. If the company has borrowed funds at 7% and has put that money to work earning 12%, then that can be a good thing. Too much debt can be trouble, though. Some major companies with not-insignificant debt include Corning
If you're interested in any of them, be sure to read up on their debt situation. A peek at footnotes in financial statements will often reveal the interest rates tied to the debt, for one thing.
Learn more about debt and investments in these articles:
- Timothy Otte: Unlocking Hidden Debt
- Bill Mann: Let's Talk About Debt, Baby
- Dayana Yochim: Got Debt? Go Ahead, Invest
