A few days ago, I was confronted with a very interesting issue by Black Enterprise magazine reader G. Scurry-Smith of Fleming, Florida: “Our family has stuck to Black Enterprise’s Wealth for Life principles for the last five years, and with a lot of discipline, we’ve reduced our debt by 50%. We teach our children these principles too. But as we watch President Obama repair the economy, we have a hard time explaining why it’s acceptable to go into debt nationally, but not personally.”
Many Americans are asking themselves the same question: Why is it fiscally irresponsible for me to borrow more money to spend, but okay for our government to do so? Let me begin my response by saying that we must all be careful not to demonize debt. It’s not all bad. That may sound strange, seeing as we’re in the midst of a financial meltdown caused by a lot of risky spending, borrowing and lending.
Think of debt in two simple categories: “goodâ€ and “badâ€. Good debt is something like a college loan, used to further your education, and therefore your earning potential. An affordable home mortgage is good debt, especially in cases where it’s cheaper than paying a monthly rent. An auto loan can be beneficial as well, if the car allows you to commute to a more lucrative job, assuming you don’t buy a more expensive car than you truly need and can afford.
Another example: A business loan to expand your chain of coffee shops into an up-and-coming neighborhood. These are all examples of debts that broaden your overall financial prospects. Some of these investments, like education or real estate, even increase in value over time. The key is keeping these debts manageable. It’s good to maintain a debt service ratio of less than 35% to 40%. In other words, the amount you pay each month to cover debts shouldn’t exceed 40% of your income.
As for “badâ€ debt, here’s an extreme example from personal experience: I got my first credit card as a sophomore in college. My first purchase? I financed a Spring Break trip to Florida for myself and a girlfriend–complete with plane tickets, rental car, and hotel. Not only was this an instance of frivolous consumption, my income at the time was a whopping zero. Very bad move.
As for the national debt: at least according to White House economists, this represents “goodâ€ debt, an investment in the nation’s future growth and prosperity. Of course, a good number of economists disagree with the administration’s deep-debt spending strategy, and many citizens are nervous about how the debt will effect future generations. Time will tell whether it was all worth it.
John Simons is the senior personal finance editor of Black Enterprise.