Good and Bad Debt

Not all debt is bad; here are some important differences between good and bad debt.

Americans are facing an ever increasing pile of debt however not all debt is bad. Debt is a financial tool and like all tools it can make our lives easier if used correctly but can be dangerous if used incorrectly. It’s important to be able to tell good debt from bad debt.

Good Debt

Good debt is debt that is of more use to you than it costs.

I think everyone could agree that if we could borrow money at 7% and invest it at 10% then we should be borrowing as much money as possible. In a similar train of thought it sometimes makes sense for us to borrow money to invest. Many people get a student loan to attend collage. They repay the debt from their salary after school. Generally people the more education you have the more you earn so paying for education is a form of investment.

Many people also borrow to buy a house. Traditionally house prices have risen over long periods of time in many countries. If the interest rate on your mortgage is less than the percentage increase in the price of your house then borrowing the money to buy you house was a good decision. Of course the trick is you never really know what your house will be worth in the future.

Another type of good debt is debt that makes purchasing some types of goods easier. Imagine trying to purchase a $50,000 car in cash. Most of us would have to wait a very long time before we could drive such a car. It might be worth paying the interest rate to lease the car and enjoy it today. It doesn’t make sense for use to spend all the money for a car in one day but enjoy it’s use for the next 3 to 5 years. Debt helps us spread the cost of expensive, long-lasting purchases over the life of the good which makes purchasing these goods easier.

Just be sure to compare rates to find the best deal and be careful not to borrow so much that the monthly payments are difficult to make.

Bad Debt

Bad debt is debt that costs you more than it’s worth. It’s like borrowing money to invest and paying 10% to borrow the money but only getting 7% return on your investment. Clearly you’re loosing money.

If you’re borrowing money to pay for inexpensive items you consume regularly then you’ll find yourself in trouble quickly. Don’t buy meals or vacations on credit if you can’t afford to pay it off immediately.

Final Word

The next time you consider using debt remember to ask yourself if it’s good debt or bad debt.