Good Debt vs Bad Debt: What’s the Difference?
When you think about the phrase “being in debt” it’s almost never a positive thing. Whether it’s a lender that you need to repay or it’s simply someone who did a favor for you and is now asking for you to return that favor, the whole idea of being indebted to someone carries plenty of negative connotations.
However, the truth is that not all debt is created equal. In fact, while it is true that you can indeed be saddled with bad debts, there are some positive aspects of debt as well. Here’s what you need to know about good debt, bad debt, and the difference between the two.
How Can Debt Be Good?
Nobody likes having to make repayments on a loan, but the truth is that sometimes having debt can most certainly lead to positive results. So-called “good” debt is, in this case, easily defined as lending that can potentially increase your economic growth. An example of this includes taking out student loans, as a higher education, by and large, increases your earning potential.
Other types of lending can also qualify as good debt. Taking out a small business loan to help you found a startup or grow an existing business can lead to better profits for your business, for example; by a similar token, taking out a mortgage leads to homeownership and the potential for a major return on your investment when you eventually sell your home somewhere down the line.
So What’s So Bad About Bad Debt?
Bed debt, meanwhile, can be defined as borrowing against something that’s not going to appreciate in value. If you need to go into debt in order to purchase something that’s not going to increase in value or help you generate income or some other return on your investment, that’s a sure sign that going into debt for the purchase isn’t a good idea unless you absolutely have no choice. Even then, you should take steps to minimize your exposure to debt in these circumstances.
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There are countless examples of bad debt. Buying a new car by taking out personal loans is, in general, a losing proposition, considering your car starts losing value as soon as you roll it off the lot. Having your own vehicle might be a necessity, but in this case, it’s a good idea to minimize the debt go into on such a purchase by saving up a generous down payment. Consumer debt, such as credit card debt, is also generally bad, especially since interest rates and fees can be so high on this type of borrowing!
The Gray Area
Of course, it’s not always crystal clear whether the loan you’re considering will end up being good debt or bad debt. There are a number of variables that come into play that can transform one type of debt to another; if your credit rating suffers because you can’t afford to repay a business loan, this will very quickly transform into bad debt. Meanwhile, making regular payments on a so-called “bad” debt like a credit card will likewise strengthen your credit rating, making it easier for you to qualify for personal loans and other types of lending in the future.
There are plenty of other situations that are borderline as well. Taking out a personal loan for debt consolidation might seem suspect, but if you can refinance existing debt at a lower interest rate you’re making an overall net gain when it comes to repayments, so this can easily be classified as good debt. Leveraging low-interest debt in order to invest those funds at a higher rate of return can also often lead to positive economic growth as well, though this obviously comes with some hefty risks of their own, making this choice not one for neophyte borrowers.
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The Final Word on Good vs Bad Debt
The truth is that there’s not necessarily any type of debt that’s completely bad or completely good. It’s important to remember that you need to follow responsible borrowing practices whenever you enter into an agreement with any lender, as the onus is, ultimately, upon you to ensure that you don’t borrow more than you can afford to repay without jeopardizing your financial security. Doing otherwise can turn even the most positive types of good debt into bad debt that can haunt you for years or even decades to come.
In the end, it’s important to strike a careful balance when it comes to how much debt you carry. Too little debt is almost as bad as too much, as you need to build a positive credit history that showcases your responsibility as a lender. Borrow conservatively, focus on good debt whenever possible, and you’ll be well on your way to building a credit rating you can be proud of for sure!
What to know about paying off debt and getting your finances back on track