Let’s start off by clearing up a major misconception many people have about debt –believe it or not, it’s not all bad. If the debt you have helps you build credit, pay down high-interest rate credit cards, or invest in your future, you have debt for the right reasons. With that being said, there’s much more to learn about the different types of debt that exist – let’s start with the good kind.
Your Debt-to-Income (DTI) Ratio can help you figure out where you stand. Find out yours now in Best Egg Financial Health.
What is Good Debt?
While it may sound like an oxymoron, good debt does exist. If you’re stuck trying to figure out if the debt you have is good, here’s a simple rule of thumb: spending money on assets that will grow in value over time or on something that will increase your long-term income is considered good debt. When managed properly, good debt could also help you increase your credit score, which furthers our point – it can’t be all bad, right?
Examples of Good Debt
- Student Loans: Preparing yourself for a lucrative career by taking out low-interest student loans can be a great idea if it increases your long-term income.
- Mortgages: Mortgages are considered to be good debt because you’re taking out a loan to purchase an asset (a home) that could appreciate in market value over time.
- Home Equity Loans: If you take out a low-interest loan and use it to make improvements to your home, it could increase the overall value of your property once it comes time to sell. To get some ideas for renovations that may increase the value of your home, take a look at our article “Guide to Choosing Your Next Home Improvement Project“.
- Debt Consolidation Loans: Consolidating high-interest credit card debt with a low-interest debt consolidation loan could save you a decent bit of money on interest payments, helping you hold onto more of your hard-earned income.
What’s the Difference Between Good and Bad Debt?
If you’re trying to differentiate between good and bad debt, ask yourself this simple question:
What will the debt provide me in the long-term?
Good debt benefits you financially in some way. After making the initial investment, you have the potential to earn more money down the line by increasing your income or owning valuable assets.
As you’d expect, bad debt doesn’t help you financially. Borrowing money to buy something that depreciates in value soon after you buy it is bad debt, because there’s no chance that you’ll be able to recoup the money that’s been invested. In addition, too much of either kind of debt can result in bad debt, as it has the potential to spiral out of control and damage your financial health.
Examples of Bad Debt
- Auto Loans: As many of us know, vehicles are generally a depreciating asset – as soon as you pull it off the lot, money is lost on your investment. Most of us need vehicles toget to work and live our lives, so all you can do is be smart about your purchase – opting for something reliable with a high resale value could be a wise choice.
- Credit Card Debt: Credit cards are a powerful tool when they’re used responsibly, but they can also damage your financial wellbeing if you’re unable to manage your monthly payments effectively. Ideally, you should pay off the entire balance each month to avoid accruing interest, but obviously that’s not always realistic – just know that if you’re spending big bucks on a high-interest credit card and only making minimum payments, your debt will likely get out of hand sooner rather than later.
A Brief Review
What Should You Do if Your Debt is Unmanageable?
Acknowledging that you’ve over-extended yourself and want to take action to overcome your financial burden is the first step in managing your debt. We’ve already written a detailed article outlining steps you can take to get your debt under control – why not take some time to check out “Ways to Manage Debt”?