Good Debt vs. Bad Debt
You can try to avoid debt all you want, but it’s unavoidable.
Whether it’s taking a mortgage to buy a house, a student loan to pay for college, or a personal loan to cover medical expenses, you can go into debt for any reason.
However, it isn’t always a necessary evil. Sometimes, it can be beneficial.
When it comes to debt, there are two kinds: good and bad. It’s important to understand both of them when you apply for a loan, credit card, or re-examine your budget.
CNET.com explains what you need to know about good debt and bad debt.
What Is Good Debt?
As mentioned above, debt can sometimes be beneficial. If you borrow money to purchase an asset that appreciates over time (like a house), that is good debt.
“Good debt is debt used to acquire appreciating assets,” Thomas E. Murphy, CEO of Murphy & Sylvest Wealth Management, told CNET. “These assets can be tangible like a house or intangible like an education. The expectation is that the asset will appreciate in value enough to offset the interest paid on the debt.”
Here are types of good debt:
Mortgages indicate that the lender that was willing to lend you a considerable amount to cover the cost of a house, an appreciating asset.
Taking out a mortgage may mean going into debt, but it also means your net worth could grow. That’s because as your home increase in value, it could eventually eclipse the cost of your mortgage. Without going into debt, your net worth would not rise in this way.
Home Equity Line Of Credit
A home equity line of credit shows that the lender trusts you will repay the money you borrowed, which is usually a significant amount. Additionally, it indicates that your home has considerable equity and that you either own it in full or have almost paid it off.
Homeowners usually take out a home equity loan to cover a large expense such as a renovation, which improves the home’s value — and your net worth. Keep in mind that lenders can consider these loans “bad” if you use the funds to buy a car, fund a vacation, or purchase another depreciating asset.
When you borrow student loans, you make a long-term investment in your future. In other words, you are the appreciating asset.
Statistically, college graduates earn more money than those with a high school diploma. Of course, some degrees are more likely than others to lead to higher-paying positions, but even so, student loans are a good type of debt.
What Is Bad Debt?
Bad debt is when you borrow money to purchase a depreciating asset — or something with no value at all. If you need a loan to finance a vacation, a car, or something else that could take a long time to repay, lenders will see it as a sign of risk.
Here are common examples of bad debt.
Auto Or Boat Loans
Cars and boats lose value almost immediately after buying them, making them a form of bad debt.
Most people need a vehicle, but while paying with cash upfront might be the best method, the only option many have is taking out a loan. When applying for an auto loan, try to negotiate with your lender or seek out interest-free loans, which are the preferred way to buy a car when going into debt.
Payday lenders are infamous for their predatory tactics, so you should avoid them at all costs. They provide short-term loans with sky-high rates to borrowers who need money quickly for an emergency or another pressing expense. Considering that interest can easily top 1,000%, these can leave you trapped in a cycle of debt — or potentially in jail.
Like debt, credit cards aren’t necessarily a bad thing. They can help you build your credit while rewarding you for everyday purchases.
Issues can arise when your credit utilization ratio, or the amount you borrowed relative to what’s available, gets too high. If you open too many credit card accounts or fall behind on your monthly minimum payments, your credit will quickly drop.
A credit monitoring service can help you stay on top of your credit and minimize the likelihood of a problem occurring. From now until April 2021, the three major credit bureaus — Experian, TransUnion, and Equifax — will let you check your credit report every week for free. Visit Annual Credit Report.com to order your record.
- Gonzalez, Oscar. “Good Debt and Bad Debt: Here’s the Difference.” CNET, CNET, 11 May 2020, www.cnet.com/personal-finance/good-debt-and-bad-debt-heres-the-difference/.