You may think that the only good debt is NO debt, and that is understandable. But the truth is that if you want to purchase big-ticket items like, for example, a house, you will most likely have to borrow money to do so. A loan to purchase a home is justifiable; essential even, and provides value while taking on debt. However, there are other forms of debt that can bog you down and make it challenging to manage your money. Let’s take a look at what the differences are between good debt and bad debt.
What is good debt?
You’ve probably heard it said that “it takes money to make money”. This is the rationale we take in determining what good debt is. If the debt assists you in generating income or building wealth, it can be considered good debt. This debt adds value to your future and benefits you in some way. Here are some examples of things that can be considered good debt:
- Education: Higher education and trade schools may offer greater earning potential. Investing in a college degree or a technical trade may pay for itself within a few years of graduation. However, keep in mind that not all degrees offer the same value, so you should do your research to have an idea of how much you can potentially earn and how long it may take you to pay off your student loans.
- Owning Real Estate or a Home: Owning a home can generate income either by renting it out or via resale value. There are also tax breaks that benefit home owners that are not available to renters.
- Owning a Business: While starting a business may require a substantial investment, that investment is still considered good debt. There are risks involved, but with hard work, being your own boss can be financially beneficial.
- Transportation: Depending upon where you live and work, transportation may be essential. This means possibly investing in a reliable vehicle to get you to and from work. Having a vehicle can open up opportunities for jobs that might not be available to you if you cannot provide your own transportation. But it is vital that you purchase a vehicle within your budget so that your monthly car payment is within your means.
What is Bad Debt?
If you borrow money to purchase things that depreciate in value, this is considered bad debt. In other words, items that either will not increase in value or bring meaningful value to your life are not worth going into debt for.
Here are some examples of bad debt:
- Clothing and Consumables: Clothes may be a necessity, but are often not worth what you pay for them. Food and furniture are also essential, but going out to eat every day or purchasing new furniture frequently are not good ways to live within your means. If you have to use credit to eat out or if you can’t pay off a credit purchase within a short period of time, you may build up a lot of debt which can hurt you financially.
- Credit Cards: Credit cards can help you build credit, but they can be dangerous if they are not used properly. If you can’t pay your credit card bill in full monthly, interest and fees will add up quickly, putting you further into debt. In fact, you may end up paying more in interest and fees than you did for the original purchase. It is in your best interest to save credit card use for necessary large purchases or for emergencies.
- Transportation: As seen above in the good debt category, having a reliable vehicle may not only be necessary, but can also provide value. However, having a second vehicle or vehicular “toy” of some kind (think boats, four-wheelers) may do a number on your budget. You need to be sure that you can afford another payment before adding something else to your monthly bills. And remember that “needs” should always come before “wants” when determining your budget.
Focus on Good Debt
If you manage your good debt, and have a clear understanding of what construes bad debt you are less likely to get in long term financial trouble. But remember…even if you don’t have bad debt it is still beneficial to pay off good debt as quickly as possible! Doing so will help you if /when you are applying for a mortgage or other loans in the future.
If you are in the market to buy or sell a home (or both), let Sandra Nickel and her Hat Team of Professionals assist you with all your real estate needs! Call them today at 334-834-1500 and check out https://homesforsaleinmontgomeryalabama.com for more information!
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