Is Debt Always Bad?

We have seen from last week's discussion how Greece is suffering from its massive debt, and from that it is very easy to assume that debt, both public and private, is alway bad... but is it?

The answer is no. Borrowing money and being in debt in the short run increases your capital and gives you the opportunity to invest in something you may not be able to afford at that moment. This is important for decision makers so that they don't have to wait until they have sufficient money and delay their investment plans. It also increases their responsiveness to the changes in the economy so that they can make their investments in a period of time where the economy is doing well.

To determine whether a debt is good or bad we must consider the balance between the risk and the return of the investment. If the risk (reflected through the interest rate) is high and the return (or net gain from the investment) is low, then overall the investment is not worthwhile and the debt is considered bad. In other words, there is no point to be in debt. On the contrary, if the risk is low and the return is high, then this is a good investment and it makes sense to be in debt in the short term. The balance between risk and return shows how easily is the debt repayable and thus is a good indication whether the investment is worthy or not.

This is why a student loan is usually considered a good debt. Education provides a valuable asset that is very useful in the future, therefore high return. The interest rate for student loans are usually very low, therefore low risk.  The same goes to real estate loans.

The key is to not to borrow excessively and be in more debt than you can afford to. Governments and individuals must evaluate and judge whether their decisions to be in debt will bring long term benefits and whether the debt will be repayable. If it is a "yes", go ahead and borrow; if it is a "no", don't bother because it is not worth your while.