For the longest time we’ve been sold this idea that all debt is bad and it’s something to avoid at all costs. It might seem strange but, not all debt is inherently evil. Undeniably, some debt is toxic however, designing the life you love involves debt. It plays a pivotal role in your plan and is not “bad” if used to fuel investment.
There are a multitude of ways to accumulate debt and learning to use debt prudently will make all the difference for you. To start, it’s important to understand the different between good and bad debt.
What is the Difference?
The simple rule is that good debt is debt that makes you money, increases your net worth, and has future value. It creates an asset or an opportunity to earn income. It is a sensible investment in your future.
Whereas, bad debt is debt that’ll cost you money. It offers little to no chance of generating returns and ultimately drains your wealth.
However, take note that all debt is bad if you can’t afford it. Here are 6 different types of debt ranked on a scale of good to bad.
Certainly, a university or college degree may be costly, but earning that degree opens the door to career opportunities and higher earning potential. In other words, these loans are an investment in your future, allowing you to make money over the years to repay the loans. A plus is that the interest rates are low and the repayment can be done once you earn more than a specific amount.
Home Loans – Mortgage
Mortgage allows you to buy a house of your own and stops you from paying rent. It’s an investment and once paid off becomes a valuable financial asset. Properties appreciate in value overtime which makes monthly mortgage payments cheaper and could generate rental income.
Businesses need capital to expand. These loans use money to make more money. Once your business takes off, it will generate enough revenue and profits to repay the loan plus interest comfortably.
Note: The outcomes discussed above are not guaranteed. If your business is going downhill, taking the loan only increases your financial burden.
Yes, you acquire an asset – your vehicle and it’ll help you get to work. However, the automobile loan can be categorised as a bad debt depending on the type of vehicle you buy. For instance, a new car depreciates and loses value to minute you drive out of the dealership. This makes the loan a grey area for debt.
Moreover, you’re paying interest (for years) on an asset that is falling in value right from the start.
Note: To be fair, a car if needed is a sensible investment so, pay as much as you can upfront.
A high-interest loan which makes it difficult to repay, putting you in a harmful financial situation. Before you know it you end up having way too many credit card debts and you’re spending money you don’t have. Aside from credit card debt, personal loans are taken to pay for things like home renovations and holidays. It’s a financial trap that hurts your pockets.
Credit Card Debt
The worst kind of debt with the highest interest. It is considered “bad” as it’s tied to buying items with no lasting value – clothes, food. Using debt to purchase everyday items will leave you in a sticky financial situation. Additionally, it reinforces a bad habit of spending money before you have it. The interest rates are the silent killer. If you’re unable to pay off the monthly debt in full, the heavy interest rates can prolong the debt payment.
Choosing the Right Debt
Protect your future self by being prudent with the types of debt you take on. Tackle the bad debts first – they are more costly and hold no value. Make sure you’re not overloaded with debt, be it good or bad. Remember, if it hurts your financial health, then even a good debt can easily go bad. The idea is to leverage debt for a better life.