Good and Bad Debt
All debt is not bad. Some debt is good. It all depends on what the debt is used for. When debt is used the right way, it can help manage your money, leverage your wealth, buy goods and services you need and handle emergencies.
On the flip side, if debt is abused it can wreak havoc on your finances and destroy your life.
Good debt can be positive if it helps to:
- Build your net worth by purchasing assets that appreciate over time. A good example is purchasing a home.
- Buy products that will pay for itself over time. An example is weatherizing your home to reduce your heating bill.
- Buy products that are essential to your daily life. An example is purchasing an automobile to transport your family and commuting to and from work.
- Invest in yourself to increase your earning potential by getting a college education or upgrading your skills.
- Pay for unexpected emergency that you don’t have immediate cash to pay for. An example of this is not having health insurance or your car breaking down.
- Using debt for convenience and rebates / cash-back. Here we are talking about credit cards. When used properly credit cards can actually make you money if you pay off your balance every month.
- Purchase nonessentials products and services that do not increase your wealth. These items depreciate in value or have very little value after purchasing. Examples of this are eating out, clothes, shoes, hand bags, music CDs, vacations, etc. Paying for these items on credit over time is throwing money in the garbage. Most of these items are paid for by credit cards which can carry high interest rates, especially if you have poor credit.
- Secure debt by using items as collateral, such as your home, that you don’t want to lose but you are uncertain if you can afford to pay back the debt.
- Have interest rate debt and make low monthly payments. Over time the value of the debt grows, which exceeds the value of the service or product you purchased. As an example, at item you initially purchased for $200 may end up costing you $350 by the time you pay all the interest.
- Using payday or cash advance loans which carry very high interest rates and trap you into keep extending the loan because you can’t pay it off.
Good vs. Bad Credit Terms
Debt can come with good credit terms and bad credit terms. Good credit terms are typically given to people with good credit. They are offered lower interest loans, larger loans and longer terms (time to payoff loan).
On the flip side, people with poor credit are offered high interest loans, smaller loans and shorter terms. Additional, people with poor credit are offered secured loans, which require them to put up collateral, such as their home or car, to get the loan. If they don’t payoff the loan the lender has to right to confiscate the collateral as payment.