Good Debt vs. Bad Debt: What’s the Difference?
July 17, 2013
A few years ago, you could walk into any bank and get a loan or go to any car dealer and get a preferred rate. Then the stock market went limp, the real estate market burst and instead of standing in line for a brand name coffee, you were in line for unemployment benefits.
Good people have fallen on hard times in every neighborhood of every town around the country. Some had to tap retirement funds and live on credit cards just to keep their heads above water. Now that things are starting to turn around, if you haven’t done so already, it’s time to take stock of the damage done.
The debts have piled up and the bill statements can be overwhelming, but remember not all debt is bad. In fact, some debt can help you turn that credit score back around. So what is the difference between good debt and bad debt? Let’s take a look.
Good Debt
Any debt that can appreciate in value over time is considered a good debt. A home mortgage loan is a good example of this. Historically real estate values have risen over time. As an owner builds equity in a house with the combination of that boost and the mortgage payments, their credit grows as well. It is one of a number of reasons why so many people invest in real estate.
Student loans are also considered good debt. Generally the loans are held at low rates, which help the student be able to afford the payments. Also, the hope is that after getting whatever degree the student is pursuing, they will be able to earn a higher salary.
These debts are only good as long as the payments are made on time. Whatever you do, if the ship is sinking, the house payment is a life raft. Everything possible should be done to make that monthly payment.
Bad Debt
It shouldn’t come as a surprise to anybody that credit card debt is bad debt. Buying that new flat screen TV using that card with a high interest rate is like stepping into quicksand. It is great for the big game or the latest action flick, but when your financial life hits the proverbial fan, that TV and all the other items or the dinners out create a huge problem for many people all over the country. They are swimming debt, struggling to make even minimum payments and the finance charges are just piling up. For those that have already drowned, it has killed their credit.
Vacation “loans†are also a recipe for disaster. Gone are the days where people would save all year for their one week away from life. In this instant gratification world, people again go with plastic planning to spend a certain amount and then working it off after the fact. In most cases, the pre-vacation “budget†goes out the window the second the toes touch sand.
This is not to say that nobody should go on vacation or buy themselves the things they want. It’s just time to get back to basics with budgeting and saving to purchase the latest thing everybody else just had to have.
Debt Management
Every person is entitled to a free credit report once a year. Pull your credit and see what is on it. Find out just what the black marks are and make a plan to fix them. Make sure to hold on to that life raft (your mortgage) and then prioritize the bad debts in order of interest rate and balance. Focus on knocking those with the higher rates off as quickly as you can.
The only plastic one should use these days is their debit card. Buy what you can pay for and nothing more. Don’t even add good debt to the pile. If you are struggling with debt, and any more is just a bad idea. Seeing a debt counselor may be necessary for some people. If that is the case, do some due diligence and find a company that is a non-profit organization built to help you. The others are just there to make money off of you and it will end up a worse situation than you are already in.
Debt, whether it is good or bad, is still your responsibility to pay back. Be vigilant about paying your bills and the chunks you take out of the debt will get bigger and bigger as time goes by.
What are some other examples of good and bad debt? Leave a comment!
Well said Ben! I think student loan debt can be bad debt, if you use it for a degree in which you struggle to make the monthly payments on the debt. Have to get a degree where the probability of finding a job is good!
Debt is debt… although you did a good job outlining what one might consider “good” vs. “bad” debt. It’s important to note that people get into just as much trouble with so-called “good debt” such as mortgages that are too large and student loans that get out of control. Just because some debt is better than others doesn’t mean it’s necessarily “good” 😉
I have never liked the terms “good debt” or “bad debt” since I believe any debt is not desirable if you can avoid it. However, if you can categorize debt based on risk then then debt such as a home mortgage (granted you can afford it meaning your house payment is not half of your income) is a risk that may be worth taking. However, since most student loans are backed by the federal government and are not bankruptable, they place tremendous pressure on students coming out of college in today’s job market. I would classify student loan debt as high risk and avoid at all costs.
I totally concur with you that consumer debt is probably the worst from of debt one can get into…carrying a debit card is a smart move. Maybe to add, i think debt incurred in starting a business is good debt, not only is it tax-deductible, to an extent, but it also creates value that grows over time. It does take some money to make money.