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What is the Difference Between Good Debt and Bad Debt?
What is the difference between good debt and bad debt? Good credit when used properly creates more money or opportunities, bad provides creature comforts and doesn't offer any other real benefit.
Most people assume that as soon as the word "debt" is used, you are automatically describing a negative situation or problem. While that is typically the case, the negative connotation that so easily follows the dreaded word debt can be misused as the different types of debt are thrown around.
So what is the difference between good debt versus bad debt, and what does it all mean? Before you hear the word debt, cringe, and run away from that particular subject. Take a moment to educate yourself about what you would be getting yourself into before you take the plunge and acquire debt.
Sometimes, when used correctly, debt can benefit your credit score and boost your overall financial backing. As long as you make the proper payments and follow all of the stipulations of your contracts.
At the other end of the spectrum, remember that debt can be dangerous and has the power to destroy your entire financial life. It is imperative that you clearly understand the difference between the types of credit and how to use them properly. Note: Of course, this information is our opinion. You would do well to consult your accountant about your situation.
What is the Difference Between Good Debt and Bad Debt?
Some definitions describe good credit and bad credit. Once you completely understand what each one represents, you can determine what types of debt you want to accumulate, and what will make up your financial lifestyle. Keep in mind that getting yourself into debt can be dangerous, and you should be careful when borrowing money from any institution or individual.
- Bad Debt
First, the definition of bad debt, or what everyone tries to avoid, should be explained. Here are some practical examples to demonstrate what you, as a consumer, should avoid. Bad debt can be considered any purchase or loan that you take on everyday objects, or depreciating items.
Are you putting groceries, clothing, or any other everyday item on credit? Can you not afford to pay the balance in full each month? Then you are accruing bad debt. These purchases are only going to increase your interest payments on credit cards. These charges, therefore, make them more expensive in the long run than if you were to have used another method of payment.
Using your credit cards to pay for a family vacation or other large payment is not good debt. You are not gaining anything tangible from it. One of the largest forms of bad debt is a car payment. The reason being that you have large interest payments on a depreciating asset. While car payments are usually necessary, they can potentially be troublesome if you have difficulty paying them.
- Good Debt
While forms of bad debt are well known to many, others are surprised to discover that another form of debt exists. A type of credit that leaves a positive impression on your financial history. The primary way to assess whether something should be considered good debt is if you can classify it as an investment.
You should think of this as something that you are investing your money in the present day, but you expect to see an increase in value at some point in your future. Overall, you will feel good about placing your capital into this kind of asset because you can expect its value to increase.
Some of the most recognizable forms of good debt lie in taking a loan out when purchasing a home, or earning your college degree. The idea behind real estate is that you are borrowing money to buy yourself land and a house in a certain area. You then anticipate it will increase in value over the time that you live there. Eventually, when you go to sell the house, you will end up gaining more money than that which you started.
The example of a college degree follows the same principle. As you pay for your school every semester and accumulate debt in the form of loans, the bank expects you to get out of school and get a job that pays well. The plan is that over your lifetime, the money you spend on your degree will pay you back many times over with your highly increased salary.
Think of good debt as money that you invest for a short or long period in which you end up making more money than you initially spent.
- Gray Areas
There are no hard and fast rules, part of what determines the value of a loan is what transpires as a result of that loan.
A car loan can be good if you need it for a business that will generate much more income than the amount of the loan.
A mortgage can be bad from a financial point of view if home prices drop and there is no capital gain.
A school loan can be bad if you graduate and never use your degree to get a job that generates income.
If its effects are financially positive or negative, don't succumb to your emotions and let them decide whether or not to get the loan, think logically.
Debt and credit are tricky subjects that can often be dangerous to get involved with, depending on your financial situation. However, most people are unaware of the terms and differences between good debt and bad debt and how each can affect an individual's lifestyle. Using this information, you may be able to make more informed decisions when it comes to handling your money.