It’s true that debt is a four-letter word. I can count the letters in the word to prove that, or simply look to my dark financial past to conclude that debt can be most troubling.
Still, the truth remains that not all debt is created equal, nor is every type of loan hazardous to your wealth.
There is a world of difference between a say a home mortgage and revolving, high-interest credit-card balances. While both are liabilities in which a borrower is legally obligated to repay a lender, the first is a good example of what I call intelligent borrowing; the latter is just stupid debt.
Here are the five characteristics of intelligent borrowing:
1. The borrower has a way to escape—a legally and morally sound alternative to get out of the obligation at any time.
2. The debt is secured. The lender holds something that is at least as valuable as the amount of the loan. This is called collateral. Think of it as a security deposit for the lender.
3. The loan is for something that has a reasonable life expectancy of more than three years as opposed to something that will be down the drain before the bill arrives.
4. The loan is for something that will increase in value, unlike a couple of movie tickets and dinner in a fancy restaurant or great new outfit.
5. The interest rate is reasonable. The best example of intelligent borrowing is a home mortgage. As of this writing, the average rate for a 15-year fixed rate mortgage is 3.84%, while the average credit card rate overall is 17.55%. Wow.