Do you Have “Good Debt” or “Bad Debt?”
Sometimes, when people are discussing debt, they talk about “good debt” and “bad debt.” You may have heard these terms before, but what do they mean?
The most straightforward explanation is that “good debt” is debt that is considered an investment in your future. The point of taking out this debt is to improve your life or your net worth going forward. An example of good debt is an investment in your education.
Postsecondary education is expensive. However, in most cases, there is also a link between having a postsecondary education and being able to get a well-paying job. Therefore, in theory, even if you have to take on debt in order to pay for education, this debt is generally considered to be “good debt” because it is an investment in your future.
Another common example of good debt is real estate. This is because buying a home and living in it for a while and then possibly selling it could likely have a financial benefit for you. You will have to take on debt in the form of a mortgage in order to afford the home, but once the payments are complete, you will own a large financial asset which is likely to increase in value over time. In addition, your monthly mortgage payments may be less than rent payments, so it makes sense in the long term.
However, not all “good debt” is always good at all times. There are always examples of situations where borrowing money for education or real estate does not work out. While borrowing money for postsecondary education generally increases your chances of getting a well-paying job in the future, nothing is guaranteed. The same is true for real estate. In general, over time, most real estate increases in value. However, this is not always the case in all situations. Therefore, even if the debt you are considering is “good debt” it is still a good idea to investigate the potential downsides of this debt. Of course, it’s also important not to take on more debt than you can afford. You need to be confident that you can make the monthly payments and still meet your daily needs.
Much like with good debt, it is tough to classify some types of debt to be “bad” 100% of the time. However, in general, debts that are considered bad are debts that are unnecessary or ones that you cannot afford. For example, borrowing money to take a vacation that you cannot afford to repay can be considered bad debt. It’s generally a better idea to save up money so that you can afford the vacation rather than borrowing money to pay for it.
Bad debt can also be debt that is used to purchase things that quickly decrease in value. For example, a new vehicle could be considered bad debt, especially if the debt involves making very high payments that impact the rest of your financial life. It’s important to note that a new vehicle could also be considered to be good debt, especially if the vehicle helps you earn money in some way (such as a vehicle for a business or a car that will make it possible for you to commute to a new job). This is an example of how a particular debt can be considered both good and bad, depending on your particular situation.
Debt is also generally considered bad if it is very expensive to repay. For example, credit card debt is often very expensive since most credit card companies charge very high interest rates. Another example of expensive debt is debt where you only put a very small amount down as a deposit on something you intend to pay for over time. Consider the new vehicle example above. If you only put a small amount of money down on a vehicle, you will end up paying more for the car in the long run due to interest costs. It’s generally considered a smarter financial decision to either buy a less expensive car or to save up until you can afford to put down a larger down payment.
Debt does not have to be bad. There are many examples of good debt out there. Generally, if you can afford to repay your debts in a timely manner, you are likely in a good financial position. However, if you take on too much debt or borrow too much at very high interest rates, then you could end up in financial trouble.