Mailbag: Explaining "Good" Debt
I've received a ton of mail from you all about mortgages, managing debt and investing wisely. I've highlighted a pair of emails below with some answers that I hope you find helpful. Stay tuned for much more on these hot-button issues...
Carmen: I don't feel that you adequately explained why mortgage debt is good debt. Beyond the tax shelter of a mortgage, what are the other benefits? Logically, wouldn't it seem that no debt is the only good kind of debt? --Tom, CA
Tom - Logically yes, but debt can be a tool to build up your net worth in amazing ways. Not to mention the biggest benefit of the 'good' debt that is your mortgage is that it gives you a roof over your head. It allows you a home that one day, should you pay it off, you'll own your home outright and in it's entirety--which is pretty amazing. Also, historically, if you stay put long enough your home gains value around 5% a year, though in some parts of the country the housing market returns much more than that.
In times like these it can seem that a home and a mortgage is just another giant hole of debt you're trying to shovel money into but never see where it really goes but equity builds only over time and with good buying decisions. Now imagine, you're paying rent of $1,800 a month for the rest of your life and you avoid debt all together. What if you were paying the same amount, but for a 30-year low fixed rate mortgage of around $300,000? In 30 years you'll own your home outright and it may be worth many, many times more than that. In retirement you'll have no housing payments and hundreds of thousands of dollars (if not a million or more) of equity. I'd say that that is 'good' debt. It's debt that pays for something you need (a home) and that grows in value over time.
Student loans are also good debt - you make more than a million more dollars over a career with a college degree than a high school diploma. Not bad for an average $25,000 investment... And I know that the $2,000 laptop I put on my credit card to go off on my own and finish my book was well, well worth it many times over. Debt can be a tool and a means to an end but mismanage it, get greedy, use it unwisely and that tool becomes a knife...
Hello Ma'am: I have just returned from Iraq and have only a mortgage payment as debt. I have noticed the increase of prices in the USA, mainly gasoline. How much money should be placed in an emergency fund and where should the money be invested? --Paul, MO
Paul - Welcome home! You're in great shape as long as that mortgage is manageable. An emergency fund should follow along with your phase in life and the requirements of your money. As long as you're free of high-interest debt (especially credit card debt), look to put away six months worth of living expenses. The function of your emergency fund is primarily to cover you and your family should someone be out of work due to layoffs or disability. However, as you move up the totem pole at your job, consider that the higher you go, the harder it may be to find a comparable position so sock away accordingly. If you have 20 years of experience and support a family, you should consider putting away enough cash to cover a full year of income.
On the other side of the coin, if you're straight out of college with no dependents, three months can hold you. As for where it should go, I mourn the loss of high-interest savings accounts. Some still exist but not the ones that used to earn us over the rate of inflation (4% a year). But you need this money to remain liquid so you can tap into it in case of emergency. So a high-interest savings account is the best place to put it.
Because you're military, look into your division's credit union. Credit unions have some of the best rates out there. For civilians, head to Bankrate.com or Interest.com and shop around for the best rates around you. And don't forget to arrange for automated savings! Having the fund filled by money that slips out of your checking account to grow in savings even before you see it takes some of the sting out of stretching to save... Good luck!