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We have always been taught that debt should be avoided at all costs, however, there are some forms of debt that provide positive financial benefits. If you want to make smart financial decisions, it is important to understand the difference between good and bad debt.
What is good debt?
Sometimes, in order to make money, you have to lose money. If you can understand that, then you can understand the premise of good debt. Good debt is any debt that is going to positively impact your life by bringing in income or increasing your net worth. Common forms of this include:
- Education: While you are in school, taking out student loans may seem like a slippery slope. However, someone with a degree will have higher earning potential and statistically find it easier to gain reputable employment. Some degrees, though, do not guarantee great compensation. That is something important to consider when taking on debt in order to attend a university.
- Your Business: Getting a business up and running is a gamble that requires quite a few loans. Luckily, if your business succeeds, the investment could support your family. Even if you chose to sell the business later down the line, it could still make you a profit.
- Your Home: Going into debt in order to own a home is an investment in your future. A mortgage is one of the healthiest debts. However, if you decide to sell, you could earn a substantial profit if you kept up with maintaining the property. Similarly, using a home as a rental property and leasing it out to others will generate consistent passive income.
What is bad debt?
Conversely, bad debt is borrowing money that is put towards “depreciating assets.” These are things that do not bring in any income and lose their value over time. Some common causes of bad debt include:
- Cars: Living without a car can be nearly impossible in most places in the United States. However, once a car is driven off the dealership lot, they begin to lose value. If you do decide to purchase a vehicle, you should take out a loan will little to no interest. You will still be paying into something that is losing value, but at least you would have avoided a high interest rate. To avoid extra costs, always drive carefully and be diligent with necessary maintenance.
- Clothes and other miscellaneous items: Clothing is hardly ever worth the price that we pay for them. It’s the same with technology like phones, video game consoles, speakers, televisions, etc. While we need clean, well-fitting clothing, access to the internet, and things that make us happier (and therefore healthier) individuals, we should not be putting ourselves in credit card debt to pay for random impulse buys. If you are using a credit card, it is important to stay on top of the payments. Otherwise, you should just use cash or budget for the occasional shopping trip or tech splurge.
Overall, debt is debt, which means that you should be careful in staying consistent with payments. Make sure that every purchase is something that you can afford either now or later down the line so you can remain on steady financial ground.
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We hope that this information on good and bad debt is helpful for you.
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