When a lender looks at your credit report to see what types of accounts you have, they will view some debts more favorably than others. If you are focused on getting out of debt, you first need to understand which debts are considered bad and which are considered good. This way, you can prioritize your debts so that you eliminate the bad debts first.
What is the difference between good debt and bad debt?
Good debt may be viewed as an investment, while bad debt is not considered an investment. Good debt is used to finance things that will increase in value, while bad debt is used to finance things that can be consumed. Examples of good debt include mortgages, student loans, and auto loans. Examples of bad debt include credit card debt and high-interest loans.
Definition of good debt and bad debt
Some of your debts might be considered an investment. You might be thinking, “How can anything as bad as debt be considered an investment?” If you have taken on debt to purchase something that will increase in value and contribute to your overall financial health, that debt may be good.
When you use debt to finance things that can be consumed, you are incurring bad debt. It’s a type of debt that creates an unhealthy financial situation.
Examples of good debt
Mortgage: Building equity in your home, and the money you pay toward the home can be considered an investment. Many people consider renting an apartment to be wasting money, while building equity when buying a home is viewed as an investment. However, this debt can also turn into a bad debt decision if you borrow more than the appropriate amount on your home or use your equity to buy things instantly.
Student loans: This debt has helped increase your earning potential, which justifies the need to borrow money. The Department of Education estimates that people with a bachelor’s degree earn about a million dollars more in their lifetime compared to workers without postsecondary education. However, you still need to set a limit on the amount you borrow. Sometimes, you can consolidate bad debt into a student loan – don’t borrow more than you need just to have extra money to spend.
Auto loans: This debt can be good if you can obtain a reasonable annual interest rate and if the car you purchase retains its value after the loan is paid off. Also, using an auto loan to get a car can open doors to better-paying job opportunities you may not consider due to transportation issues.
Examples of bad debt
Credit card debt: This type of debt is considered bad due to the nature of the items purchased using credit cards. You should not use debt to buy everyday items like clothes or food. If you use a credit card for these types of purchases, it should be intentional, for example, to earn rewards knowing that you will pay off the balance in full by the due date.
High-interest loans: Payday loans and some personal loans can carry extremely high-interest rates. For example, the Consumer Financial Protection Bureau indicates that some payday loans can impose annual percentage rates as high as 400% including the fees you pay to borrow.
How to focus on good debt and avoid bad debt
Getting into the habit of incurring good debt while avoiding bad debt takes practice and a shift in your thinking.
Good debt is incurred through wise decisions about your future, not just for the sake of acquiring good debt. For example, you may decide to obtain a master’s degree to increase your earning potential. Getting a student loan if you have no other way to finance your education can be a valid reason for taking on additional debt.
Handle
With your debt repayment strategy also wisely. It is usually a good idea to focus on paying off bad debt first, as it may cost you more in fees and interest than good debt and does not have significant appreciated value. You should pay off credit cards and auto loans before dealing with mortgages or student loans.
Some people consider using good debt to pay off bad debt, such as taking out a mortgage for $110,000 instead of $100,000 and using the surplus to pay off credit card balances. This may not be a good idea for several reasons: it will take longer to pay off the mortgage, the higher mortgage will increase your monthly payments, and the higher mortgage will prolong the time it takes to build equity in your home.
Pay Attention to the Amount of Debt You Borrow
Your choices about how to spend your money are related to whether the debt is considered good or bad. It’s important to remember that any excessive debt or debt used to purchase wants instead of needs should be avoided.
Additionally, good debt versus bad does not mean you should borrow all the money available to you. Use good judgment when making decisions about borrowing money. You may regret buying a home if you find yourself living in a poor home due to debt. It is advisable to keep your debt-to-income ratio below 35% of your income.
And when you think about borrowing more money to buy something, be deliberate. Ask yourself the following questions: Will I have something to show for this money in one year or five years? Is it something I need immediately (like paying for car repairs or a medical condition)? Can I save money to buy it instead? Is there an alternative way to pay for this?
Pay Off Debt as Quickly as Possible
Even if the debt is considered good debt, you should work on paying off your debts as quickly as possible. This will allow you to start building wealth. It can also help you achieve your dreams because you will not rely heavily on your paycheck each month.
There are many reasons to get out of debt. If you are serious about getting out of debt, you will need to set a budget and a debt repayment plan that allows you to apply more money to your loans each month. You can pay off your debts faster than you expect if your money is managed properly. This might mean taking on an extra job for a short time or downsizing your lifestyle, but the sacrifices will be worth the effort.
Conclusion
Good debt is the type of debt that can be considered an investment, such as mortgages, student loans, and auto loans. These debts are taken to purchase something that will increase in value or contribute to overall financial health. While bad debt is used to purchase material things, such as credit card debt and high-interest loans. Although bad debt may make you happy, it does not provide any kind of return on investment that puts you in a better financial position than you were before.
For most people, having a certain level of debt is almost impossible to avoid. But making smart borrowing decisions, along with knowing the types of good and bad debt, can help ensure that your debt does not spiral out of control.
Source: https://www.thebalancemoney.com/good-debt-vs-bad-debt-960029
.lwrp .lwrp-title{
}.lwrp .lwrp-description{
}
.lwrp .lwrp-list-container{
}
.lwrp .lwrp-list-multi-container{
display: flex;
}
.lwrp .lwrp-list-double{
width: 48%;
}
.lwrp .lwrp-list-triple{
width: 32%;
}
.lwrp .lwrp-list-row-container{
display: flex;
justify-content: space-between;
}
.lwrp .lwrp-list-row-container .lwrp-list-item{
width: calc(12% – 20px);
}
.lwrp .lwrp-list-item:not(.lwrp-no-posts-message-item){
}
.lwrp .lwrp-list-item img{
max-width: 100%;
height: auto;
object-fit: cover;
aspect-ratio: 1 / 1;
}
.lwrp .lwrp-list-item.lwrp-empty-list-item{
background: initial !important;
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
}@media screen and (max-width: 480px) {
.lwrp.link-whisper-related-posts{
}
.lwrp .lwrp-title{
}.lwrp .lwrp-description{
}
.lwrp .lwrp-list-multi-container{
flex-direction: column;
}
.lwrp .lwrp-list-multi-container ul.lwrp-list{
margin-top: 0px;
margin-bottom: 0px;
padding-top: 0px;
padding-bottom: 0px;
}
.lwrp .lwrp-list-double,
.lwrp .lwrp-list-triple{
width: 100%;
}
.lwrp .lwrp-list-row-container{
justify-content: initial;
flex-direction: column;
}
.lwrp .lwrp-list-row-container .lwrp-list-item{
width: 100%;
}
.lwrp .lwrp-list-item:not(.lwrp-no-posts-message-item){
}
.lwrp .lwrp-list-item .lwrp-list-link .lwrp-list-link-title-text,
.lwrp .lwrp-list-item .lwrp-list-no-posts-message{
};
}
Leave a Reply