Debt has become a normal part of some people’s life. People end up in debt for so many reasons and most of them are not good. It is very important for you to understand the difference between good debt and bad debt because debt has the ability to take your finances in the wrong direction easily. The differences are listed below.
A debt is said to be good if it helps you increase your net worth or helps increase your income. Some examples of good debt can be:
- Real Estate Debt – This is one of the primary examples of good debt. This type of debt is quite often a good investment opportunity if handled correctly either you purchase a home to live in and sell it for more down the road or if you purchase commercial real estate and rent it out or sell it to businesses.
- Business Debt – If handled appropriately; taking out a loan to support your current business or a new business venture can be smart. Before you do this, you need to make sure a good business plan has been put in place and also make sure you have the ability of repaying the loan within a reasonable amount of time. Most times, loans are what businesses need to thrive as it can be a source of capital to grow and prosper.
- Educational Debt – Student debt is a perfect example of good debt because it helps you to increase your earning potential. When you’ve completed a degree in higher education you are more likely to be paid higher and to have an easier time being hired. While this is an example of god debt, it’s also important that you don’t carry this debt for longer than necessary. Be sure to work repayment of your student debt into your budget as soon as possible so you don’t carry it for too long. You should aim to have it repaid within a few years.
A debt is said to be bad if it is used to purchase assets that will depreciate in value over time and does not have any ability to generate any income. Some examples of bad debt include:
- Goods and Services – The amount you spend in money and interest on things like clothing, electronics, vacations etc cannot be recouped. Maintaining debt on these things as they won’t improve your financial standing typically is a very good idea.
- Credit Cards – The most common type of bad debt is the one that comes from credit cards. Interest rates tend to be high and carrying a balance will ensure you pay more out of pocket on your purchases than what their original value was.
- Auto Loans – Cars depreciate in value the moment you drive them off the lot. The cost of vehicles is high, and depending on the type of loan that you’ve taken out to purchase it, you could wind up paying more in interest on the vehicle than you should. Also, by the time you go to trade in or sell the car, you’ll be getting back a substantially less amount for it than you initially paid. It’s usually a good idea to pay for a car in cash whenever possible.
- Debt Consolidation Loans – This may be a good option for you to more easily and quickly pay off your debts. It is however considered a bad debt because you will be taking on more debt in order to eliminate an existing debt. It may also put you in a better financial state when handled appropriately. It will not increase your net worth or bring in more cash flow. . It’s also possible for debt consolidation to place you in a worse credit position than before if you don’t pay off your debt within a reasonable amount of time, default on the loan, or if you continue to accumulate debt after consolidating.