By Jonathan Chevreau National Post FP Money Section Saturday, September 18, 2004

As any experienced financial writer knows, there's good debt and there's bad debt. This column last tackled this chestnut in April, when it opined that the only good debt was no debt. So I was intrigued if somewhat abashed when this week I received an advance copy of a book entitled Good Debt, Bad Debt.

You won't find it in stores until January, but you can get a sneak preview by setting your Web browser to www.gooddebt.com.

Author Jon Hanson -- an American Baby Boomer who made his fortune in real estate -- says there are three kinds of good debt. They are debt incurred to fund education, investments or income-producing real estate, and to start or grow a business.

Almost everything else is bad debt. As the book's cover blurb proclaims, "Knowing the difference can save your financial life."

Bad debt we're all too familiar with: debt used to consume stuff we don't really need with money we've not yet earned, and to do so sooner than later. Credit cards are the major facilitator of bad debt. Hanson dubs these "the crack cocaine of the credit industry."

Ironically, the book arrived just as publicists for the Bank of Montreal were pitching that "credit cards can be rewarding." Of the 80% of Canadians with credit cards, 77% have at least one "reward" card, it said. Meanwhile, in a similar spiel, KidsFutures continues to urge parents to "spend your kid to college."

Like the poor, such distractions will always be with us. Those who succumb to the siren song of debt will likely remain poor. Hanson reminds us "the goal of Madison Avenue (New York's advertising district) is to distract you while the merchants of debt pick your pockets."

Of course, the credit pushers extend well beyond loan sharks in three-piece suits. New car loans and "no down payment" furniture or appliance loans are in the same category. Nor is Hanson enamoured of the popular American pastime of refinancing homes to keep consumption going.

In short, bad debt decreases your net worth and reduces your cash flow, while good debt increases your net worth, helping you make money.

The numbers of "bad debt" victims are legion. Hanson assures us these "money nerds" are destined to spend their lives "dashing up the financial down-escalator."

He even categorizes regular monthly commitments to luxuries like cable TV as variants of bad debt, or what he dubs "paradebt." Similarly, he dismisses a daily Starbucks coffee habit as a harmful example of "Mcspending." He formally defines this as "promiscuous small amounts of spending we don't often account for."

That's just one of several trademarked neologisms Hanson coined over the two years he wrote his book. Debt junkies he terms "Consumerati," many afflicted with the dread disease of Debtabetes, or Financial Diabetes. They are experts at rationalizing, or telling themselves "rational lies."

Their polar opposites are the frugal savers and investors he terms the "Econowise."

These two camps have a profoundly different understanding of the power of compound interest. You lose when debt interest charges impoverish you. You win when compound interest from savings and investments keeps adding to your wealth.

As Richard Russell writes at www.dowtheoryletters.com, "he who understands interest -- earns it. He who doesn't understand interest -- pays it." Russell's site has archived one of his most popular essays, Rich Man, Poor Man, which expounds the power and virtue of compounding, whether through interest, dividend or rental income.

Hanson's prescription is simple and hardly novel: live below your means and pay yourself first.

So how do Canada's financial advisors view the two kinds of debt? Jim Rogers says good debt arises:

1. Where the benefits of borrowing are believed to be greater than the costs of borrowing

2. Where repaying the debt can be handled well within the borrower's surplus cash flow.

When borrowing to invest, interest costs can be deducted from taxable income. Such borrowers make the implicit assumption the investment's after-tax return will exceed their after-tax cost of borrowing, Rogers says.

Consumers are less apt to analyze credit card debt. Instead of looking only at the "low minimum monthly payment," they should consider the following.

Unlike investment loans, interest charges for consumption is not tax deductible. For those in the 30% tax bracket, Rogers estimates an 18% interest charge has an opportunity cost equivalent to forgoing a 26% return on an investment that could have been made with the interest payments on the debt.

“Incurring non-deductible debt is one of the biggest impediments for Canadians to accumulating the nestegg," agrees Adrian Mastracci, of Vancouver's KCM Wealth Management Inc., "Borrowers should try to incur interest costs deductible for tax purposes whenever possible, and pay off non-deductible loans as quickly as possible."

Warren Baldwin does not recommend leveraged investing and views as "very bad debt" aggressive leverage where clients aren't prepared to weather market downturns.

Therefore, he's "tempted to say that no debt is good and all debt is something to be paid down aggressively."

Baldwin sees only a few exceptions. One is mortgage debt to facilitate the purchase of a family's first home. And for emergencies a line of credit can be good debt as long as nothing is owed on the line and you shop around for the lowest rates.

Me, I like to keep it simple. The best debt is no debt at all.

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.