To get out of debt, you need to understand which debts are bad for you and which are good. This way, you can prioritize your debt to avoid bad debt first.
There is certainly an argument that there is no good debt at all, yet borrowing money and getting into debt is the only way for many people to buy important things like a house. There are two types of debt: justified and beneficial to the person taking on the debt, and others that can be harmful if not handled carefully.
This article will help you differentiate between the two so you can make the most of taking loans without getting yourself in financial trouble over time.
So let’s begin!
An introduction to good vs. bad debt
Good debt can be beneficial if it helps you generate income and build your net worth. So are debts that improve the lives of you and your family in other important ways.
As for bad debts, borrowing to purchase an asset likely to depreciate is generally considered a bad idea. In other words, if it doesn’t appreciate or generate income, you shouldn’t go into debt to buy it.
As a quick comparison, if you bought something that will increase in value and can help you financially, like an asset, it may be a good idea to take on debt to purchase it. On the other hand, when you borrow money to buy things that can be used or consumed, you’re taking on bad debt, like a liability that brings no monetary value to the table.
Examples of good debt
When considering long-term assets, if you’re taking debt for your education, business, or real estate, it can be considered good debt because it pays you back in the long run.
1. Student loans
The more education an individual has, the more money they can make. Education has a positive correlation with finding employment. A well-educated workforce is more likely to be employed in high-paying jobs and is more likely to find new work if it is needed.
A college or technical degree can often help you get a good job and make you money pretty quickly. There is no “right” answer when choosing a degree, as the long-term prospects for different fields vary. It’s important to consider short- and long-term opportunities when deciding.
2. Personal/business debt
Starting your own business can be a great way to use your financial resources productively. Borrowing money can be considered good debt, as it will help you get started in your business and help you grow it. Being your boss can be both financially and psychologically rewarding.
3. Mortgage debt
There are many ways to make money in the real estate market. On the residential front, one common way to buy a home is to take out a mortgage and live in the home for a few decades. Then, when you’re ready, you can sell the home at a profit.
Residential and commercial real estate can both be used to generate income by renting them out. If you know what you’re doing, you can earn a lot of money by investing in these properties, so a property loan is always a good debt as long as you have planned it right.
Examples of bad debt
Buying things for fashion, pleasure, or trends isn’t bad. However, acquiring debt for these reasons sure is a bad decision. Here are some common debts people gain without realizing they’re hurting their financial standing:
1. Car loans
If you can’t live without a car, borrowing money to buy one is not a good idea from a financial perspective. When you leave the car park, the car is already worth less than when you bought it.
Looking for low or no-interest loans if you need money to buy a car? You will invest a large amount of money in a depreciating asset, but you will not pay interest.
2. Credit card debt
This is often considered a bad debt due to the items the credit card purchases. Using debt to purchase items like clothes or food is not advisable. If you use a credit card for these purchases, it must be done on purpose, such as to earn rewards in the knowledge that you will pay off your entire balance by the due date.
You may be tempted to use your credit card to take a vacation because you think you’ll be more productive when you return by taking a break. However, this may not always be the case. Thing like this has no tangible value even if it has legitimate benefits and will pile up to throw you off financially.
Your spending habits reflect your opinion of whether or not a debt is considered good or bad. It’s important to be careful about debts that are too large or used to buy things you don’t need.
While the debt may be good for you in terms of its terms and interest rate, it’s important to consider other factors before borrowing all the money available. Use good judgment when deciding to borrow money.
If you end up being house poor due to owning a home, you may regret your purchase. We recommend keeping your debt-to-income ratio below 35% of your income and focusing on saving more money!