good debt vs bad debt

The Truth about Good Debt Vs. Bad Debt

When we hear the word debt, many of instantly have negative connotations. We think that owing any kind of money is always bad. 

However, the truth is, certain types of debt can work in your favor. Debt that goes towards paying off items that appreciate in value or add to your self worth can be beneficial. This article will review different types of debt so you can tell the good from the bad.

Good Debt vs. Bad Debt: What’s the Difference?

Before we get into which types of debt are good and which are bad, let’s look at why certain types of debt are better than others. 

Good debt has the potential to increase your net worth. Bad debt, on the other hand, involves borrowing money to buy assets that depreciate. These will make your net worth go down as their value decreases. 

What Types of Debt are Good Debt?

Now that you know the difference between good and bad debt, let’s look some types of debt that would fall under the good debt category.

Student Loans: If you are paying off a loan on your college education, it could be considered good debt. It means that you attended a school to learn a skill that will add to your net worth. 

However, a student debt isn’t always good. It is only beneficial if you used that degree to make money to bring in enough revenue to justify the debt. Also, like any other debt, if you fall behind on your payments, it will not look good on your credit report. 

Small Business Ownership: Owing money to pay off small business loans can also be seen as good debt. A small business has the potential to earn you a lot of money and it will also add to your net worth. 

In order for small businesses loans to really help your credit, your business should be bringing in some revenue and you should not be falling behind on loan payments.

Home Ownership or Another Type of Real Estate: Owning real estate can also add to your net worth. You might own your own home, you may own commercial property or you may own a property that you rent out to others. Either way, as long as you keep up on payments, the mortgage you owe on these properties are a form of good debt. 

Bad Credit

Owing money on goods that depreciate is considered bad debt. Here are a few examples of the kind of debt you don’t want to have. 

Car Payments: No matter how nice your car is, its value will depreciate over time and any type of balance owed will be considered bad debt. Not only will it damage your net worth, it will result in interest payments that add to the initial cost. 

It is for this reason that it’s a good idea to pay for your car outright. Of course, cars are expensive and it’s not always easy to pay them off in one payment. However, it may be worth it to find an inexpensive, used car to avoid being buried in bad debt. 

Consumer Goods and Services: Clothing, appliances, furniture and other consumer goods will also depreciate over time. Just like a car, you are best paying for these items outright to avoid interest payments and bad debt. 

Credit Cards: Credit card debt is also considered bad debt. To clarify, experts say that carrying some credit card debt and making regular payments can improve your credit score. 

However, if you’re not in a place where you need to boost your credit, you are better off avoiding putting anything on credit. The interest rates just aren’t worth it.

Other Types of Debt

While some types of debt are easy to classify as good and bad, it is not as simple to put other types of debt in a category. These types of debt can be good for one person and bad for another. Here are some examples. 

Consolidation Loans: Consolidation loans are for people who are already in debt. The idea is to pay off higher interest debt with a lower interest loan. Consolidation loans can be beneficial if they are being used to pay for items that gain value as time goes on. They are also good if they can successfully get someone out of debt. 

Borrowing to Invest: Also called leveraging, this process involves borrowing money at a low interest rate and investing at a higher rate of return. While this is a good way for some investors to make money, it comes with its share of risks. Not only can inexperienced investors lose money on their investments, they also might end up owing money to their broker for the borrowed funds. 

Obviously, this type of debt is only advantageous to those that are successful. 

Credit Card Rewards Programs: Credit card rewards programs allow consumers to use the money they spend on credit cards to pay for travel, get cash back or get other types of benefits. While this is a win win for many people, it can be damaging to those who are unable to make their payments on time. 

It is also only worth it if the value of the rewards outweigh the money you are spending on interest. 

Debt is not always bad. It really depends on what you’re spending your money on and how it adds to your net worth. Which types of debt do you think are worth it?