Is a debt-free life the best way to live?

June 17, 2011: 3:30 PM ET

NEW YORK (Money) -- I often see advisors refer to "good" debt. I have no debt, not even a mortgage. And I find that living debt free is comforting. I don't think any debt is good. Do you agree? -- Don Rogers, Raleigh, N.C.

In a word, no.

Granted, debt can lead to big problems for individuals as well as countries, witness Greece's woes. But that doesn't mean that everyone has a realistic shot at living a debt-free life, or that they should even aspire to do so.

Take me, for example. I'm particularly leery about taking on debt, but I have a mortgage that I'm still paying off. I took out loans to pay for college too, but I paid those off many years ago.

In both instances, I think it made perfect sense to borrow. In the case of my mortgage, my wife and I decided after the birth of our son that we'd rather raise him in a house with a yard than in the cramped apartment in New York City.

We paid cash for our million-dollar home

Without a mortgage, it would have taken us many years to scrape together enough dough to pay cash for a house. So for the improvement in quality of life alone, taking on a mortgage was a good move.

As for the school loans, it would have been impossible for me to get through college without them. From a purely financial point of view, the loans were a bargain, as they allowed me to get an education that has helped me earn more than I would have been able to otherwise. That education has helped me in lots of other ways, too. (For a recent report on the benefits of higher education, click here).

So when it comes to debt, I don't think total abstinence is a smart way to go. Rather, you should evaluate your finances and your goals and then decide whether borrowing is sensible and practical in a particular situation.

Among the questions you should ask yourself:

  • Why are you taking on the debt?
  • Is it for something you truly need or will it make your life significantly better?
  • Can you get what you want without the debt or without inflicting undue hardship on you and your family?
  • Will borrowing restrict your ability to maneuver financially in the future?
  • How much debt can you handle without jeopardizing your financial security?

I think most people who give those questions serious thought can distinguish between when it pays to borrow and when it doesn't.

If you decide to borrow in order to own a home, fine. But that doesn't mean you should buy more house than you can really afford by taking on more debt than you can manage or by opting for a mortgage with a teaser rate that could bust your budget when the rate resets.

No credit card, no 401(k), no problem?

The same goes for a car. Borrowing to buy a car that makes it easier to commute to work is reasonable. Buying a luxury-mobile with a loan so huge that the crushing payments force you to forego or skimp on 401(k) contributions, well, that's not so smart.

Of course, just because people are capable of making these distinctions doesn't mean they always do. In reality, people find all sorts of ways to rationalize questionable borrowing. Sometimes they confuse "need" with "want." I may want that new 70-inch LED LCD TV. But do I actually need it?

Or they justify borrowing on investment grounds. A few years ago when it seemed home prices were only going up, I warned about the practice of "equity maximization," or borrowing against home equity for the purpose of investing the loan proceeds.

Other times, the deals seem so good they may not even realize they're headed for trouble. That's often the case with credit cards, where a combination of easy borrowing, teaser rates and low minimum payments makes it all too easy for people to suddenly find themselves in over their heads.

It seems to me, though, that the right reaction isn't to avoid all debt at all times because it might lead to financial perdition. Rather, a more rational response is to be prudent about when to take on debt.

Speaking of prudence, there is one time when I think people should seriously consider ridding themselves of debt, if not entirely -- at least mostly. And that's when they're in or entering retirement.

Without a regular paycheck coming in and the opportunity for your income to grow, it's that much harder to manage debt -- and easier to get overwhelmed by it. (For more on whether it pays to use retirement savings to pay down your mortgage as you enter retirement, click here.)

But even in retirement there may be times when debt could be helpful. If someone is struggling to get by but has substantial home equity, a reverse mortgage may be a way to improve his or her standard of living.

So I recommend taking a nuanced view that allows for the fact that debt can be good, bad or something in between, depending on the situation and how carefully you handle it.

For guidance on when debt may and may not make sense and tips on managing it, I suggest you read our MONEY 101 lesson on Controlling Debt.

And while you're at it, check out our Debt Reduction Planner. That MONEY 1010 lesson, by the way, is aptly named. Because if you don't control your debt, it can easily end up controlling you. To top of page

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