Good Debt vs. Bad Debt: What’s the Difference?
Debt is the result of borrowing money, whether you are take out student loans to finance your education, get a mortgage to buy a house, or just use a credit card to do your groceries. While some types of debt are bad, there is good debt. Here’s how to tell them apart.
What is good debt?
Generally, a debt can be considered good if it helps or benefits you in a positive way.
“Good debt is any debt that increases your net worth and / or will provide you with future returns,” said Krystal Pino, certified public accountant and founder of Nomad Tax.
It’s important to note, however, that good debt can turn into bad debt if it’s not handled properly. For example, paying late or defaulting on good debt can negatively affect your credit score if it is billed as bad debt.
Examples of good debt
Student loan debt is often referred to as good debt since you are investing in your education. Ideally, this investment pays off once you graduate and use your degree to land a good job. The reward for taking on student debt is higher earning potential.
A mortgage is also considered good debt since it is attached to a specific asset i.e. a house.
“Mortgages generally carry low interest rates, and the long term makes monthly payments manageable,” Pino said. “The interest on a mortgage is also tax deductible, and ideally the value of your home will increase over time, generating a return on your investment. “
Business loans can also be classified as good debt if taking out a loan allows you to increase and increase your profits. Auto loans or personal loans to pay off medical debt can be considered good or neutral debt, depending on the interest rates you pay.
What is a bad debt?
Bad debts are the opposite of good debts in that there is probably no long-term reward or benefit to paying for them. And the interest rates you pay on bad debt can make it more expensive to borrow.
Examples of bad debt
Credit cards can be considered bad debt if they have a credit card attached to them. annual percentage rate (APR). If having a balance means paying 15%, 20%, or more interest on things that have no long-term value, like dining out, then this is a great example of a bad debt.
Alternative installment loans, such as payday loans or title loans, can also be added to the bad debt category. While these types of loans are convenient, they can be one of the more expensive means of borrowing due to the high fees charged by payday and securities lenders.
Personal loans can be between good debt and bad debt. A low interest personal loan to renovate your home and increase its value would be good debt. On the other hand, getting a personal loan with a high APR to go on vacation is a bad debt.
How to deal with good and bad debt
With good debt, like a mortgage or student loan, the best ways to manage it are to pay it off on time each month and look for opportunities to lower your borrowing costs. Refinancing of student loans at a lower rate, for example, could save you money on interest while lowering your monthly payments. The same is true for refinancing a home loan.
In the event of bad debt, such as credit cards, high interest personal loans, or installment loans, you should look for ways to pay these bad debts.
As for how to get out of credit card debt, for example, you might consider a balance transfer to make it more affordable. A balance transfer can be the best way to consolidate credit card debt if you can do it at a 0% interest rate. Debt consolidation loans are also an option for paying off credit cards and other bad debts.
Are Debt Consolidation Loans a Good Idea? Maybe, if you can get one at a low interest rate and try not to create additional bad debt.
However, the key to managing both good and bad debt is to focus on paying it off.
“Just because debt is considered good debt doesn’t mean you have to bear it,” Pino said. “And make sure you are able to maintain minimum payments; defaulting on payments can hurt your credit score. “