How You Can Avoid Bad Debt
Almost everyone has some debt. Whether it comes in the form of a mortgage, a car loan, or credit card debt, it can be tough to get through modern life without borrowing money at some point. However, certain debts can be more dangerous than others. These debts are tough to repay and can cause big financial problems. That’s why they are commonly known as “bad debts.”
Once you end up in a situation where you’re responsible for paying off bad debts, things can get out of control very quickly and you could end up in significant financial trouble. That’s why it’s important to take debt seriously. A good place to start is by understanding the difference between good debt and bad debt.
What is Bad Debt?
As mentioned, in general, most people have some debt. However, having unnecessary debt or debt that you can’t afford to repay can hurt your financial situation. That’s because debt comes at a cost. You have to dedicate money each month to paying off your debts and you need to pay interest on the amount you owe as well. Depending on the type of debt, these interest costs can be significant.
In general, bad debts are those debts that do not improve your financial situation or ones that are used to buy items that aren’t necessary and that depreciate in value. An example of bad debt for most people is credit card debt.
However, it can sometimes to tough to tell the difference between good and bad debt. That’s often because each person’s financial situation is unique.
How is Bad Debt Different from Good Debt?
“Good debts” are debts that improve your financial position. A typical example of a good debt is a student loan. If you borrow money to pay for postsecondary education, you put yourself in a position to have more job prospects and that means you will likely improve your financial position over time. Mortgages are also often considered to be good debts. Making your mortgage payments helps you build equity in your home, and once your mortgage is paid off, the value of your home will likely have increased.
However, even student loans and mortgages can be considered bad debts in some situations. If you borrow more than you can comfortably afford to repay, for example, this could be a problem. It can also be an issue if your schooling doesn’t result in you getting a job or if your home decreases in value. As you can see, whether a debt is considered good or bad can depend on the specific circumstances.
That said, many debts are considered to be “bad” in nearly every situation. Credit card debt, especially when the debt is a result of buying luxuries and “wants” rather than “needs” is almost always a bad debt. This debt won’t result in an improvement in your financial situation. When possible, avoid taking on these debts.
How to Avoid Bad Debt
One key to avoiding bad debt is not spending more than you can afford and not borrowing money without a plan to pay it back. As mentioned, some debts are considered “good” in certain situations but “bad” in others.
For example, consider an automobile loan. If you need to have a vehicle to get to your job, borrowing money to buy a car could be considered a good debt. That’s because owning the car would allow you to get to work and going to work improves your financial situation.
However, that’s not to say that you should go out and buy a luxury vehicle if you can’t afford one. Buying an expensive car, or taking on a car loan with expensive terms, can cause serious financial hardship if you’re not able to make the payments, or if you’re only able to make the payments by making significant sacrifices in the rest of your life. You don’t need a high-end vehicle to get to work, so taking on this debt may not be a good idea.
That’s generally a good way to think about debt. If a debt isn’t necessary or isn’t affordable, consider whether it makes sense for you. Before you take on any debt, truly think about the purchase. Is it necessary? Do you have plan for how you will pay off the debt? Is there a more affordable option that makes sense? If you ask yourself these questions, if you stick to your budget, and if you don’t borrow more than you can comfortably afford to repay, you will be in a stronger financial position and you will avoid bad debt issues.