One of the biggest misconceptions I see around the current views of millennials’ finances is what assets are good to acquire using debt. We are constantly bombarded with the notion that taking out debt to get a college degree will leave us forever paying off our student loans, and therefore we will never be able to get ahead. But no worries, it is totally fine to take out that $25,000 loan to buy that new car you really want. These messages are completely wrong, and here’s why.
Taking out a student loan to get a college degree is usually a good investment. Sure, you need to review the tuition you’ll be paying against your potential earnings, and avoid taking on extra debt to pay for a really cool apartment, but it’s a good decision more times than not. This is because a degree from an accredited university is an appreciating asset. An appreciating asset will gain value over time. I think college degrees are overlooked assets because they are intangible, or an asset you can’t touch, unlike a house. However, getting a college degree usually affords you a higher starting salary out of college, and sets you up to make more money in the long run. You get more opportunities for promotions, and the ability to advance your career by applying for jobs at other companies that you would otherwise not be qualified for. Therefore, since the trajectory of your income should increase over time, and outpace the income growth of a person without a university degree, I would argue that this is a great use of debt. You will incur interest on your loans, and could be paying them off for many years, but with proper planning your potential earnings increase should outweigh the total loan and interest you will end up paying.
Unlike with student loans, I never hear the argument that people shouldn’t take out a car loan. Instead, I constantly hear commercials saying that I can go get a car today with $0 down! But unlike college degrees, cars are depreciating assets. Cars lose value over time. If you use debt to buy a new car, your car will end up costing you the loan amount, plus the interest. While you’re paying more money for your car than the sticker price, your car will be losing value until it is only worth the value of its scrapped parts. By taking out a car loan, you are agreeing to pay more for your car, and never make any money on your new, shiny, depreciating asset. If houses did this would you still take out loans to buy them? You’d take out a home loan for $250,000, end up paying around $350,000 in total on the loan with interest, and then you could only sell your house for the scrap value of the drywall. I bet this seems like a horrible investment. So why would you do this with a car?
As a basic rule, if the asset will depreciate, debt is the wrong choice of financing. Instead of opting for a car loan, open a savings account and begin saving up to buy yourself a new car. With proper due diligence, debt can be a great tool to build wealth. Debt can also leave you paying much more for something than you intended, and having little to show for it. In the words of my husband, “play the game to win, not to play.”