While all of us would like to get through life as debt-free as possible, this is very difficult to do. For many people, any major life change from purchasing an automobile or house to getting married or earning a degree requires some type of loan. Many financial advisors will tell you that there are two main types of debt: good and bad debt. Heres a look at what they mean by that.
Good debt is an investment with an eye towards a future payoff. An investment in a brand new business is seen as good debt, since the company is, theoretically at least, supposed to earn money in the future.
A mortgage is also good debt, since your home will hopefully increase in value and you may sell it for more than you purchased it for.
A student loan for a traditional or accredited online degree is also considered good debt. That’s why an investment in your education is supposed to be paid off.
Statistics show that this is usually the case, an individual with a bachelor’s degree makes an average of $400,000 more over their earning lifetime than someone with only a high school degree. An individual with a master’s degree makes an average of 38.3% more than someone with a Bachelors’s alone, and a Ph.D.
Some forms of good debt include mortgages and student loans and they are also tax-deductible. Nevertheless, its important to point out that what’s considered good debt does not automatically pay off.
Your home could very well decrease in value as many individuals found out throughout the latest economic recession. A large proportion of business startups don’t become profitable, so investing in a brand new business is also not a guarantee.
Additionally, despite the statistics on the high average earnings of Ph.D.s, many individuals with doctorate degrees don’t make considerable amounts of cash.
Some fields pay much more than others, and a Ph.D. isn’t always a good bet. Whether or not financial advisors label your debt bad or good, if your investment does not work out, it might be just as devastating financially.
Bad debt is debt that doesn’t increase in value. Samples of bad debt include credit card debt along with other forms of regular consumer debt, as well as payday loans, and automobile loans. Generally, bad debt carries an increased risk that you will ultimately wind up overpaying for what you purchased with the debt.
High credit card rates of interest, for instance, mean that you will pay considerably more for whatever you purchased with your credit card than you’d have if you’d paid the full amount upfront. While this is also true for things such as student education loans and mortgages, the rates of interest for these kinds of debt aren’t as high and what you purchased is supposed to pay you back in the long term.
Credit card debt is not necessarily always bad debt for example if you used a corporate credit card to purchase supplies for your company, that could be construed as good debt.
Although you purchase an automobile ultimately for a good reason an automobile loan is considered a bad debt. The reason is because car values decrease over time so unless you invest in an classic car your purchase isn’t very prudent. The proper choice would be to buy a cheaper car.
FAQ Frequently Asked Questions About Good Debt and Bad Debt
What can good debt do to your credit score?
High credit card debt can have a negative effect on your credit, however, good debt, that is within your means, can be a great way to build your credit score.
An auto loan, for instance, can help diversify the types of debts on your loan history, thus improving your credit score.
What hurts your credit score the most?
Since your payment history is on of the most important factors on your credit history, missing a payment or a 30-day late payment can have the greatest negative impact on your credit score. The second factor that has the highest impact is using too much of your available credit balances.
Is it good to be debt free?
Having no debt is better than having bad debt, however, having good debt that is managed wisely can be a great financial move. When debt is managed responsibly it can have a positive effect on your credit score.
Last Things You Need to Know About Good Debt vs Bad Debt
Good debt can be attained by adjusting the choices you make. Take into account your financial situation by making a financial plan and learn the proper ways to manage your money according to your own personal situation. Then you can decide which debts are appropriate for you to take on.
Be careful not to take on too much debt even in the case of good debt. It is better to save money for purchases than to go into debt you can’t pay.
We Want to Hear From You: What do you think is another good debt? What advice do you have for others dealing with good debt vs bad debt?