When people think about debt, they often see it in a completely negative light. However, there’s a lot you might not know about the difference between “good debt” and “bad debt.” What makes some debt better than others, and how do you understand where you currently stand with your own debts?
No matter when you’re thinking of borrowing money, it really does pay to be fully informed about your options. There are lots of good debts that could enhance your life as well as bad debts that could cause a lot of problems. With that in mind, what’s the difference between good debt vs. bad debt?
To help you keep your finances in better standing, we created this guide to share everything you need to know about good debt vs. bad debt. Read on to learn more and learn what steps you need to take control of your own debts.
What Is Good Debt?
First, when you think about good debt, you should simply think of it as a positive investment. This kind of debt is normally taken on for a specific reason, and it should improve a person’s financial outlook well into the future.
This kind of debt is usually taken on in order to make a profit at a later date. However, it’s essential that you establish a plan to pay back your debt without missing any payments. Taking on a good debt should mean that there is very little risk attached.
Regardless of this, don’t forget that every debt does carry a risk. For instance, something might be a good debt for someone who’s on top of their finances and can afford their repayment plan while the same debt has someone else stuck living paycheque to paycheque.
As you might expect, the difference between good debt vs. bad debt isn’t so black and white. To put this in perspective, let’s look at the biggest examples of good debts and what makes them so appealing.
Mortgages
A mortgage is often thought of as being a huge milestone in anyone’s life. This is definitely a good type of debt and one that you should certainly consider taking on. Not only will you’ll have a place to call home, but this will become one of your biggest financial assets once paid off.
As an added bonus, mortgage repayments normally end up far cheaper than renting property. In the long run, a mortgage improves your credit and saves you money. That means it’s a great option for most people.
Education or student loans
Investing in your education is one of the best ways to build a better future. For starters, university graduates normally have higher salaries than non-graduates. In addition to this, student loans quite often come with a salary threshold that determines when you pay it back and have some of the lowest interest rates on the market.
While it might be intimidating to take out student loans, especially if you’re young and just starting out, these are usually a great investment. Debt can be a necessary stepping stone to move up the financial ladder.
Investments
Perhaps it’s the right time for you to invest in stocks, bonds, commodities, real estate, forex, and the like. A smart investment plan can help you reap substantial profits in the future or generate an annual dividend.
However, it’s critical to remember that with any investment comes risk. Make sure you seek the advice of qualified professionals before taking on any debt in order to make an investment.
Business expenses
If you’re a business owner, you might need to take on debt to invest in your future. If your business succeeds, you could potentially increase your income over time. However, it’s normal to take on debt along the way to pay for products, equipment, supplies, staffing, and more.
The key is to be wise with your business and your funds. With some luck and a lot of hard work, this could be a shining example of good debt.
What Is Bad Debt?
On the other hand, bad debt isn’t a good long-term investment. If you’re trying to work out what makes a debt bad, simply look at how it’s going to affect you in the long run.
Bad debt is often taken on by people who don’t fully consider the future consequences. Bad debt will often cause a purchase to depreciate in value, carry high interest rates, and generate little or no future income.
The key difference between good debt and bad debt is the long-term investment potential. Bad debt rarely pays off, and it can lead to even more financial troubles. Some of the most common examples are these below.
Credit cards
Though there are valid upsides to credit cards, they can easily become one of the worst types of bad debt that you could face. The key point to remember with credit cards is that the interest rates are often extremely high.
While one credit card can be hard enough to handle at the best of times, having many different ones can cause your monthly repayments to get out of control and lead to significant financial difficulty. If you do have credit cards, choose wisely and read the fine print. In addition, never spend more than you can afford.
Car loans
Let’s face it: nothing looks quite as enticing as a shiny new car. With the price tag that normally comes with a new car, you’d expect it to be a sound investment. However, cars depreciate in value dramatically from the minute you leave the car lot.
Instead of investing in a brand new car, consider joining a car sharing program, buying second hand, or paying for an affordable car lease if you don’t need to drive all year round. A used car that you plan to keep for several years is a much better debt than a large loan for a fancy new car.
Personal loans
While there is a time and place for personal loans (like debt consolidation), personal loans that are taken on for discretionary purchases is an example of bad debt. If you take out a loan for a holiday, expensive new clothes, or something you don’t really need, this is likely going to cost you more in the long run.
Though these interest rates tend to be better than credit cards, they’re still high. That means you’ll end up paying more long-term than if you had simply saved for an expensive purchase outright.
Payday loans
If you’re ever tempted to get a payday loan, then you need to reconsider your options immediately. Payday loans are probably the worst kind of bad debt that you could take on. They are designed to entice vulnerable people to agree to astronomical interest rates.
What makes these loans so dangerous? If you miss payments, even once, you could be liable to pay thousands of dollars more than you originally borrowed. This leads many to fall into what’s known as the payday lending cycle.
We can help!
Ultimately, if you’re tempted to take on any kind of debt, make sure it’s the good kind instead of the bad. While we’ve covered the main differences between good debt vs. bad debt, it will take your better judgement to make the right call.
However, if you’d like professional advice on good debt vs bad debt, contact our experts now. If you’re having trouble with debt, learn how Debt Busters can help you overcome your financial problems today. With over a decade of experience helping people of all backgrounds tackle their debt, you don’t have to face the path ahead alone.