Not all debt can be measured equally. In reality, some types of debt can be beneficial and help you achieve your financial goals.
On the other hand, some debts can be detrimental and lead to financial stress.
The key is understanding the difference.
Determining good debt and bad debt is crucial for making informed financial decisions.
What is Debt, and why do you need it?
Debt is owing money to someone, whether it be from a loan or credit card use.
It's that simple!
However, contrary to popular belief being in debt is not always a negative thing.
So while owing money may seem daunting, responsible management of debt can have its benefits.
What is Good Debt?
Good debt is debt that is used to invest in something that will increase in value over time and helps you build wealth.
For example, taking out a mortgage to buy a home can be considered good debt because it allows you to invest in a valuable asset that can appreciate in value over time, and it provides you and your family with a stable and secure place to live.
Plus, as you make payments on your mortgage, you are building equity in your home, it can provide tax benefits that are not available to renters.
Lastly, if you choose to rent out your property, you can generate income and potentially increase your overall net worth.
Taking out a student loan to invest in your education can also be considered good debt because it can potentially increase your earnings and help you achieve long-term financial stability.
Taking out a loan to start a business or invest in real estate can be considered good debt because it has the potential to increase your income and net worth over time.
Anything that can potentially boost your future financial well-being.
What is Bad Debt?
Now, what's bad debt?
Examples of bad debt include credit card debt, high-interest personal loans, and payday loans.
These types of debt often come with high-interest rates and fees, making it difficult to pay them off and potentially leading to a cycle of debt.
Credit cards that are not earning you rewards and that you're using to make unnecessary purchases are dangerous. It can quickly spiral out of control and lead to financial hardship.
Payday loans are predatorial due to the astronomical interest rates they charge.
Car loans are considered bad debt because they depreciate in value so quickly. However, a car loan can be hard to avoid depending on your circumstance.
If you find yourself overwhelmed with bad debt, a debt consolidation loan can be a good option to help you pay off your debts and save money on interest payments.
How to manage your debt effectively
Start by creating a budget and prioritizing your debt payments.
Focus on paying off high-interest debt first, such as credit card debt, and consider consolidating your debt with a lower-interest loan if possible.
It's also important to avoid taking on new debt unless it is necessary and can be managed responsibly.
Quick Tips to Help You Manage Debt:
Always pay on time
Pay more than the minimum
Take on new debt only when needed
Negotiate for lower rates
Build an emergency fund
Major take away
Debt can be a friend, not one you want to rely on but one that can get you through a season.
Good debt can help you build wealth. However, bad debt can deplete your wealth.
It's important to prioritize paying off bad debt before taking on more good debt and always to have a plan for managing and paying off any debt you take on.