6. Should You Ever Go Into Debt?

Why credit card debt isn’t always bad


In the desert, the vast majority of flowering plants fall into one of two categories—annuals and perennials. Annuals are plants that grow, reproduce, and die all within one season, while perennials are those that can live through multiple seasons.

But there’s something odd about annuals that live in the desert—every year a portion of their seeds don’t germinate. This is true even when the conditions for sprouting are optimal.


From the outside looking in this behavior doesn’t make any sense. After all, why would a plant that lives in a harsh environment like the desert not take full advantage of good conditions when they present themselves?

The answer has to do with rainfall or, rather, the lack of rainfall. Since desert annuals require sufficiently wet conditions in order to sprout and grow, rainfall is what determines their survival. However, in an environment as unpredictable as the desert, dry spells sometimes occur.

If a desert annual were to sprout all of its seeds and then experience one of these extended dry spells, all of their offspring would die. That’s game over for their lineage. As a result, some seeds remain dormant as a way of coping with an uncertain future.

This behavior, known as bet hedging, is a risk-reduction strategy that seeks to maximize an organism’s long-term reproductive success. It’s not about maximizing offspring in any one year, but over time.

While bet hedging is advantageous for organisms trying to maximize their reproductive fitness, it can also be used when determining whether you should ever take out debt.

Why Debt (Even Credit Card Debt) Isn’t Always Bad

Debt. It’s a topic that has been debated since biblical times. As Proverbs 22:7 states, “The borrower is slave to the lender.”

However, is debt always bad? Or are only some kinds of debt bad? Unfortunately, the answer isn’t so straightforward.

For example, if you had asked me years ago whether you should ever take out credit card debt, I would have given you the same answer as every other financial expert: “Under no circumstances.”

But after spending more time studying how people use debt, I realized that this advice wasn’t always right. Obviously, the high interest rates charged by credit card companies are something that should be avoided. But I know you already know that. Everyone knows that.

However, what you may not know is how credit cards can help reduce risk for some low-income borrowers. This is most easily demonstrated by what researchers have called the credit card debt puzzle. The credit card debt puzzle is the observation that some people hold credit card debt despite having the ability to pay it off from savings.

For example, imagine someone with $1,500 in their checking account who also has $1,000 in credit card debt. They could easily pay off that $1,000 debt and still have $500 in their checking account, but they don’t. Their decision to hold onto their debt might seem irrational, but after taking a closer look, it’s just a form of bet hedging.

Researchers Olga Gorbachev and María José Luengo-Prado discovered this when analyzing individuals who had both credit card debt and liquid savings (“borrower-savers”). What they found is that these borrower-savers tended to have different perceptions about their future access to credit than everyone else.30

In other words, people with both credit card debt and savings tend to be worried about whether they will have access to money in the future. As a result, they willingly give up some short-term reward (by paying interest on their credit cards) in order to reduce the long-term risk of not having sufficient funds. What seems foolish on the surface is actually a legitimate money management technique.

But this isn’t the only reason why someone might take on high interest debt. In the book Portfolios of the Poor, the authors discovered, to their surprise, that some of the world’s poorest people actually use debt as a way to save money.

For example, a woman named Seema, from the town of Vijayawada in southern India, took out a loan for $20 at a 15% monthly interest rate despite having $55 in her liquid savings account. When she was asked why she did this, she stated:

“Because at this interest rate I know I’ll pay back the loan money very quickly. If I withdrew my savings, it would take me a long time to rebuild the balance.”31

Seema, like many other poor borrowers around the world, used debt as a behavioral crutch to force herself to save money. From a purely mathematical perspective this might seem irrational. However, if you understand human behavior, it makes sense.

This is why labeling debt as good or bad misses the point. Debt, regardless of the type, is a financial tool like any other. If used properly, it can work wonders for your financial situation. If not, it can be harmful.

The difference depends on context. Though I don’t expect you to ever take out credit card debt, it can be helpful for understanding when you should consider taking out debt in general.

When You Should Consider Debt

Though there are a lot of reasons why someone might consider taking out debt, the most useful ones tend to fall within two buckets:

1. To reduce risk.

2. To generate a return greater than the cost to borrow.

When it comes to reducing risk, debt can be used to provide additional liquidity, smooth cash flow, or decrease uncertainty. For example, someone may choose not to pay off their mortgage early so that they can have more cash on hand in the event of an emergency. In this case, the optionality provided by holding debt can be worth more than the cost to hold it.

Debt can also be used to decrease uncertainty when locking in a payment stream into the future. For example, if you want to live in a particular area, taking out a mortgage can fix your cost of living for the next few decades. Because of that debt, you no longer have to worry about changing rents or housing security since your future payments are known and unchanging.

In addition to reducing risk, debt can also be utilized to generate a return greater than the cost of borrowing. For example, when it comes to paying for an education (student loan), starting a small business (business loan), or buying a home (mortgage), the cost of borrowing can be lower than the return it eventually generates.

Of course, the devil is in the details. If the difference between your expected rate of return and your cost to borrow is too small, then taking out debt could be a risky move. However, when the expected return is large, debt can change your life. One area where this is typically true is in higher education.

Why College is Worth It (Most of the Time)

Despite the rising costs of college, the lifetime earnings of college graduates exceed those of high school graduates by a sizeable premium.

According to a 2015 report from the Georgetown University Center on Education and the Workforce, the median annual earnings of high school graduates aged 25–29 was $36,000, compared to $61,000 for college graduates.32 The annual difference in earnings is only $25,000, but over a 40-year career that adds up to $1 million.

This $1 million figure is what has been thrown around in the media as to what a bachelor’s degree is actually worth. Unfortunately, this figure doesn’t consider that you earn this money over time (the time value of money) nor the demographic differences of the people who tend to get bachelor’s degrees.

For example, if we took a student who was about to attend Harvard and forced them not to attend any college whatsoever, they would likely earn far more than the typical person with only a high school degree.

When researchers controlled for these kinds of demographic factors, they found that the lifetime earnings premium for a college graduate (over a high school graduate) was $655,000 for men and $445,000 for women. Additionally, after adjusting for the time value of money (bringing future earnings to the present), the lifetime earnings premium of a college education was $260,000 for men and $180,000 for women.33

This means that, on average, men should be willing to pay up to $260,000 for a college education while women should be willing to pay up to $180,000. Of course, these amounts represent the break-even amount one should be willing to pay for a college education. Ideally, you would need to pay less than this to make it financially worthwhile.

In addition, these estimates are only on average. Since earnings vary so much across majors, the decision about whether college is worth it ultimately comes down to what major you choose. For example, the estimated difference in lifetime earnings between the lowest paying major (early childhood education) and highest paying major (petroleum engineering) was $3.4 million.34

Therefore, when determining whether getting a particular degree is worth the cost, you need to estimate how much it will increase your lifetime earnings and then remove any lost earnings from attending the program.

For example, let’s assume you want to get an MBA because you think it will increase your annual earnings by $20,000 per year over the next 40 years (compared to not having an MBA). In that case the expected increase in your lifetime earnings would be $800,000.

The proper way to find the current value of these future earnings is to discount this payment stream by 4% per year. However, there is a simpler way to approximate this—divide the increase in lifetime earnings by two.

This will be roughly equivalent to a 40-year payment stream discount by 4% per year. I prefer this shortcut because you can now do the math in your head. Therefore, a $800,000 increase in lifetime earnings over 40 years is worth about $400,000 today.

Lastly, you should remove any earnings you would lose from attending school. So, if you are earning $75,000 a year and you want to get an MBA, you should remove $150,000 (two years of earnings) from the present value of the expected increase in lifetime earnings.

Putting it all together, today getting your MBA is worth:

($800,000/2) - $150,000 = $250,000

A quarter of a million dollars. This is the most you should be willing to pay for an MBA that earns you $800,000 more over your lifetime, assuming you currently earn $75,000 a year.

You can do this calculation for a different degree by using your own set of numbers and plugging them into the same equation:

Value of Degree Today = (Increased Lifetime Earnings/2) – Lost Earnings

While things like taxes and other variables can affect this calculation, it’s still a simple way to check whether a degree is worth the cost.

If you run the numbers, you will see that going to college (and taking out debt to do so) is still worth it for most undergraduate and graduate programs.

For example, we know that the average public university student in the U.S. borrows around $30,000 to get a bachelor’s degree.35 We also know that the average annual out-of-pocket cost to attend a public four-year school is $11,800.36 This means that, over a four-year period, the total cost (out-of-pocket cost plus debt) of attending a public university is $77,200 ($11,800 × 4 + $30,000).

For simplicity’s sake, let’s round this to $80,000 (or $20,000 per year). Assuming the lost earnings over four years would be $120,000 (or $30,000 per year), we can plug these numbers into our formula above:

$80,000 = (Increased Lifetime Earnings/2) – $120,000

Solving for the Increased Lifetime Earnings, we would rearrange the formula such that:

Increased Lifetime Earnings = ($80,000 + $120,000) × 2


Increased Lifetime Earnings = $400,000

This implies that lifetime earnings would need to increase by roughly $400,000 (or $10,000 per year) for the typical bachelor’s degree at a public university to be worth it. While some undergraduate degrees may not be able to provide a lifetime earnings boost of this magnitude, many of them will.

This is why taking out debt to finance a degree is typically an easy decision. Unfortunately, when it comes to taking out debt to buy a home or start a small business, the calculus is less clear.

Of course, all of the above is only considering the financial cost of taking out debt, but there can be non-financial costs as well.

The Non-Financial Costs of Debt

Taking out debt can be much more than a financial decision. Empirical research has demonstrated that it can affect your mental and physical health as well, depending on the type of debt.

For example, research published in the Journal of Economic Psychology found that British households with higher levels of outstanding credit card debt were “significantly less likely to report complete psychological well-being.”37 However, no such association was found when examining households with mortgage debt.

Researchers at Ohio State echoed these findings when they reported that payday loans, credit cards, and loans from family and friends caused the most stress, while mortgage debt caused the least.38

On the physical health front, a study in Social Science & Medicine found that high financial debt relative to assets among American households was associated with “higher perceived stress and depression, worse self-reported general health, and higher diastolic blood pressure.” This was true even after controlling for socioeconomic status, common health indicators, and other demographic factors.39

In all these studies, non-mortgage, financial debt was the culprit. Ideally, you should avoid this kind of debt, when possible.

However, this doesn’t imply that other kinds of debt can’t cause you stress. In fact, depending on your personality, you may want to avoid debt altogether.

For example, a survey of college students found that those with much thriftier attitudes around money expressed more concern about their credit card debt, regardless of the level of debt that they had.40

This suggests that some people will always have a strong aversion towards debt even if they aren’t in financial trouble. I know a few people who are like this. They paid off their mortgage when they didn’t have to, simply for the peace of mind.

Though their decision wasn’t optimal financially, it may have been optimal from a psychological point of view. If you happen to be debt-averse, then you may find it helpful to avoid all debt despite some of the benefits outlined above.

Debt as a Choice

After reviewing the literature on the financial and non-financial costs of debt, I have found that those who benefit the most from using debt are those who can choose when to take it. If you can use debt strategically to reduce risk or increase return, then you may be able to benefit from it.

Unfortunately, many of the households that currently utilize debt don’t have this luxury. According to Bankrate, among the 28% of individuals who had an unanticipated expense in 2019, the average cost was $3,518.41 This cost is significant and can explain why lower income households would need to take out debt to cover it.

More importantly, expenses like this are almost guaranteed to occur for every household at some point in the future. If we assume that the probability of having an emergency expense each year is 28%, then the probability of having at least one emergency expense over five years is 81%, and over ten years is 96%!

Unfortunately, those who rely on debt to cover an emergency expense can end up in a vicious cycle that is hard to escape. As LendingTree noted at the end of 2018, one-third of Americans were still in debt from a prior emergency expense that they couldn’t cover.42

Though many of these households will find a way out of debt, a significant portion of them won’t. As researchers at the Federal Reserve discovered, though 35% of U.S. households experience financial distress (i.e., severe debt delinquency) at some point in their lives, 10% of them account for roughly half of all distress events.43 For a minority of households, debt isn’t a choice but an obligation.

I highlight this point because if you are someone who is considering debt then you are more fortunate than you may realize.

Now that we have discussed debt generally, let’s tackle the most common debt decision that most people make—should I rent or should I buy a home?

30 Gorbachev, Olga, and María José Luengo-Prado, “The Credit Card Debt Puzzle: The Role of Preferences, Credit Access Risk, and Financial Literacy,” Review of Economics and Statistics 101:2 (2019), 294–309.

31 Collins, Daryl, Jonathan Morduch, Stuart Rutherford, and Orlanda Ruthven, Portfolios of the Poor: How the World’s Poor Live On $2 a Day (Princeton, NJ: Princeton University Press, 2009).

32 “The Economic Value of College Majors,” CEW Georgetown (2015).

33 Tamborini, Christopher R., ChangHwan Kim, and Arthur Sakamoto, “Education and Lifetime Earnings in the United States,” Demography 52:4 (2015), 1383–1407.

34 “The Economic Value of College Majors,” CEW Georgetown (2015).

35 “Student Loan Debt Statistics [2021]: Average + Total Debt,” EducationData (April 12, 2020).

36 Radwin, David, and C. Wei, “What is the Price of College? Total, Net, and Out-of-Pocket Prices by Type of Institution in 2011–12,” Resource document, National Center for Education Statistics (2015).

37 Brown, Sarah, Karl Taylor, and Stephen Wheatley Price, “Debt and Distress: Evaluating the Psychological Cost of Credit,” Journal of Economic Psychology 26:5 (2005), 642–663.

38 Dunn, Lucia F., and Ida A. Mirzaie, “Determinants of Consumer Debt Stress: Differences by Debt Type and Gender,” Department of Economics: Columbus, Ohio State University (2012).

39 Sweet, Elizabeth, Arijit Nandi, Emma K. Adam, and Thomas W. McDade, “The High Price of Debt: Household Financial Debt and its Impact on Mental and Physical Health,” Social Science & Medicine 91 (2013), 94–100.

40 Norvilitis, J.M., Szablicki, P.B., and Wilson, S.D., “Factors Influencing Levels of Credit-Card Debt in College Students,” Journal of Applied Social Psychology 33 (2003), 935–947.

41 Dixon, Amanda, “Survey: Nearly 4 in 10 Americans Would Borrow to Cover a $1K Emergency,” Bankrate (January 22, 2020).

42 Kirkham, Elyssa, “Most Americans Can’t Cover a $1,000 Emergency With Savings,” LendingTree (December 19, 2018).

43 Athreya, Kartik, José Mustre-del-Río, and Juan M. Sánchez, “The Persistence of Financial Distress,” The Review of Financial Studies 32:10 (2019), 3851–3883.

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