Good debt vs a Bad debt and The Impact on your Finances

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It can be argued that no debt is good. However, distinctions can be made about the types of debt we as consumers are taking. Borrowing money has become such an easy thing to do that most us don’t stop and analyze our use of it. I’m sure you’ve heard some references about “bad debt” and “good debt”. But what exactly do these expressions mean?

What’s considered “Good debt” ?

“Good debt” is money you borrow for an investment or to purchase an asset that appreciates over time. For example, borrowing to start a new business is considered good because by investing in a profitable business you are not only able to make more money but you are also able to repay the loan with interest and increase your cash flow.

In this case, the loan helps you reach you dream quicker. The alternative to borrowing would have been to save money first ( for however long that may take) and then start your business. You shave off months if not years in order to reach your financial goals faster.

Getting a mortgage is also considered “good debt” as you are borrowing to purchase real estate. The reason this is considered “good debt” is because real estate generally appreciates over a period of time, although there are no guarantees. You are also borrowing at lower interest rate with a mortgage which is why it’s considered “good debt”.

Home Equity Line of Credits can be considered “good” or “bad” depending on what you use the borrowed funds for. A Home Equity Line of credit is a loan that is secured by the borrower’s house. It allows the account holder to borrow funds at a lower interest rate than most credit accounts. If you use the funds from the Home Equity Line of credit for an investment, then it’s considered “good debt”.

What’s considered “Bad debt” ?

“Bad debt” is borrowing money to finance a rapidly depreciating asset (i.e. a car, clothes, a boat, electronics etc.) or to purchase property that does not generate a revenue. If you are borrowing funds to purchase a TV or new shoes, it means you are taking on “bad debt” because you can’t afford these items.

A car loan is considered “bad debt” because the property you are purchasing, meaning the car, is a depreciating asset. Did you know that a new car loses up to 20% of its value within the first year of its purchase? This is not to say that you shouldn’t buy a new car but you should only purchase a car you can afford.

Credit card loans are also considered “bad debt” essentially because of the high interest rates and how most people use them. Credit cards are not bad financial products. It all depends on how they are used. Credit cards can be a great financial product if used properly.

Pay day loans are definitely considered to be “bad” because of the extraordinary high interest rates and huge fees associated with them. You should try to stay clear of these types of loans as much as possible.

Not all debt can be classified as either “good” or “bad”. There are special circumstances like debt consolidations that fall in a different category. If you currently have high interest loans, it can make sense for you to take a debt consolidation loan with a financial institution.

This new debt helps you not only combine all your unpaid loans into one account but it also helps you save on interest because consolidation loans usually have lower interest rates than most credit cards. I guess this type of loan can fall in the “good debt” category as you are essentially trying to improve your financial health by paying less interest over your debt repayment period.

Bottom line

Taking on debt is the only way most people can have access to capital in order to start an investment or purchase big ticket items like real estate. Any debt can be considered good or bad depending on your use of the borrowed funds. As long as you are using borrowing with an educated approach to reach you financial goals, you are using debt intelligently and won’t have any issues.