Overview
What distinguishes something as good debt vs. bad debt? For many people, when they hear the word debt, they automatically assume it’s bad. However, while the term debt may carry some negative connotations, not all debt is inherently bad.
In fact, used correctly, debt has the potential to benefit you in the long run, and can be used to get ahead in life. But what is good debt and what is bad debt? Here are some examples that might help you to understand:
What is good debt?
One of the best examples of good debt is an investment in your future, helping you grow financially in the long run and increasing your net worth over time. Although there may be interest on good debt, the returns or profits tend to be higher if you play your cards right.
Examples of good debt include:
Student Loans: Getting a higher education may be considered good debt, as it creates a path for career opportunity. Although, if you do not plan on using your degree after graduation, going into student debt loan may not be the best option for you.
Mortgage: Taking out a loan for a property is considered good debt, as properties are often good investments. If you choose to rent out your property, you will see an instant return on the cashflow, and your tenants will help to pay off your mortgage!
Business Loans: Although a business loan may be a risk, it may also be considered good debt if you succeed! Through a thriving business you will be able to pay back the loan, and turn a profit!
While any loan involves financial risk, these loans can contribute to your growth as a wealthier and more successful individual.
What is bad debt?
Bad debt can be viewed as any type of loan or debt that does not increase your net worth or benefit your future financially. Bad debt can quickly spiral out of control, so it is important to spend and invest wisely in your future.
Examples of bad debt include:
Long term credit card debt: If used irresponsibly, credit card debt can rack up a high interest!
Credit cards are a very useful tool and can be beneficial, with reward points and insurance just a few of the possible benefits. However, it is not good to borrow on them long term since the interest rates are very high. If you need a longer term option to help manage your finances, a personal loan or line of credit will likely have lower interest.
Car loans: As a general rule, borrowing money to buy something that will decrease in value might not be the best idea. The reason for this is, if circumstances require you to pay off your debt immediately, selling the asset won’t cover the cost of the debt. Car loans fall into this category, since cars tend to drop in value as they get older. However, if you need a reliable car for your job and can negotiate a decent rate, borrowing to fund a car purchase could have potential benefits and be considered good debt..
Payday loans: the short-term nature of these loans means the interest is usually much higher than on a traditional personal loan. That can make it a very expensive option.
Bad debt can be dangerous as it may accumulate high interest rates, fees, and penalties, as well as reduce your credit score, making it difficult for you to get approved for credit cards, mortgages, or future loans.
Good Debt Vs. Bad Debt: Tips for Avoiding Bad Debt
One thing they don’t teach in school is how to balance your finances. It is essential to stay on top of your earnings and spending to ensure you maintain healthy spending habits.
How to stay on top of your finances:
Create a budget, including your income, expenses, and residual income. Consider saving or investing your residual income where you can.
Use credit cards responsibly! Don’t spend what you do not have the means to pay back.
Avoid impulse spending! If you are an online shopper, close that clothing app before checking out! If you still want the items in a few hours, consider whether or not you truly can afford to buy it at this moment.
Build an emergency fund! We can’t predict the future, so it’s best to prepare for it!
How to Manage Bad Debt
As mentioned above, bad debt can easily spiral out of control. Therefore, finding ways to manage bad debt is crucial. It is important to stay on top of your finances to avoid slipping into a slope of debt. If you find yourself in a situation where your debt is starting to get a little bit out of control, consider taking these steps to get back on track:
Prioritize your debt payments. Make sure to pay off your higher interest rates first!
Consolidate your debt. This may lower the interest on all your debts and loans, which will result in lower payments.
Reach out to a financial advisor or credit counselor for guidance!
Understanding the distinction between good debt and bad debt is crucial for making informed financial decisions. While good debt can serve as an investment in your future, contributing to long-term financial growth, bad debt can lead to detrimental consequences. By adopting responsible financial habits, such as budgeting, using credit cards wisely, and building an emergency fund, you can mitigate the risks associated with debt.
If faced with the challenges of managing bad debt, prioritize payments, consider debt consolidation, and seek guidance from financial professionals. Striking a balance between financial responsibility and strategic investment can pave the way for a more secure and prosperous future.
*The views expressed in this article are solely those of the author and are provided for information purposes only, and does not under any circumstances constitute legal, financial or other professional advice to be relied upon. When considering debt options or financial considerations, we strongly recommend engaging the services of a financial or legal professional to help determine the appropriate considerations for your circumstances. Acting on any of the information in this article without consultation of a professional is done so at the sole risk and liability of the reader.
