07/03/2013 12:20 EDT | Updated 09/02/2013 05:12 EDT

Give Me Liberty, or Give Me Debt

Close-up of businessman with pocket out

The standard answer to the question "Is debt bad?" is that there is good debt and there is bad debt, so debt on its own is neither good nor bad.

Conventional wisdom says that debt used to purchase something of lasting value, like an investment, or a house, or a car, is good debt, because you benefit from the purchase. An example of bad debt would be borrowing to go on vacation, because when the vacation is over you have nothing to show for it. In some cases both of these examples are true.

If you get an RRSP loan and pay it off with your tax refund, and if your RRSP increases in value, you can make the case that it was a smart financial move to incur the RRSP loan debt. If you get a mortgage to buy a house and the house increases in value, you can argue that you are better off because you used debt to buy your house.

Of course for every successful investment story I can tell you a story of someone who used borrowed money to invest in the stock market before it crashed and they were wiped out. I have filed many bankruptcies for hundreds of people who lost their house because they owed more than it was worth. Focusing on who made or lost money by using debt is missing the point. Anecdotal evidence proves nothing.

I prefer to view debt differently.

Instead of looking at debt as good or bad, I look at debt as something that either increases or decreases your freedom.

Getting a mortgage to buy a house increases your freedom, because you can live in the house you want. However, making a huge mortgage payment each month limits your freedom if you have no money left over for a dinner out with friends, or a vacation, or a new pair of shoes. That's what we call "house rich and cash poor." If you can't afford to live a normal life because of your high level of debt, your debt is bad debt.

In my experience, the problem is that we focus on today, not tomorrow. We have no problem financing a $30,000 car, because the payments are "only" $400 per month. We focus on the $400 monthly payment, not the $10,000 in interest we will pay over the life of the loan. If you realized that your $30,000 car will cost you $40,000, would you still buy it? Or would you consider buying a much cheaper used car, but pay for it with cash?

Would your answer change if you knew that in the next year you would lose your job, or be off work for medical reasons, or have a marriage break up? If you knew your income will drop in the future, you would probably take on less debt today, because you don't want the burden of big debt payments on low income.

So ask yourself, do you want debt, or do you want freedom?