Line of Credit
Q: Would you recommend taking out a line of credit?
Full Question
I need to pay for school and finance some personal projects. Would you recommend taking out a line of credit?
Answer
Many people believe there are three types of debt: bad debt, good debt and “best” debt.
Bad debt would be when you borrow money to buy something that depreciates in value. A good example of this would be a big screen TV, for instance. You might buy it for $2000, and by the time you pay it off you will have paid $3000 out of pocket. But from the first day onwards, its value goes down. By the time you pay off your loan, what you bought may not be worth very much anymore.
Good debt would be when you borrow money to buy something that goes up in value, or provides a return on your money. The best example of this would be borrowing money to buy a house. Over long periods of time, houses are expected to increase in value. Eventually the mortgage will be paid off, and you’ll own your home free and clear, and it will hopefully have also increased in value.
“Best debt” would be when you borrow money to buy something that goes up in value and the interest on this loan is tax deductible. Being able to deduct the interest on your loan is like getting a discounted interest rate charged on the money borrowed. An example of this would be borrowing money to invest (outside a registered account), or borrowing money to go to school. Not all school programs will qualify for interest deductibility, so it would be wise to check first. The school you are applying to will be able to answer that question and also help you make sure that you take all the right steps to qualify and maintain the deductibility of the interest on your student loan.
So to answer your specific question:
- Make sure to check with your educational institute about qualifying for a loan for which the interest is deductible. If you do qualify, do not co-mingle the use of funds with your personal projects that you want to finance – use a separate loan or line of credit for that. If you don’t keep them separate, you will lose the deductibility of the interest on your loan.
- As for whether to take out the loans or lines of credit in the first place, you need to weigh the benefits. Schooling has definite long term benefits, but for the personal projects you can use the above guide on different types of debt to help you with your decision.