Good Debt vs Bad Debt

As talked about in my "About" section, at a young age, I didn't realize the negative effects having good credit could be, more so how having good credit can lead to a tremendous amount of bad debt. I started building my credit little by little; paying bills on time, having said bills in my name (cell phone, car insurance), etc. It got to a point to where I was able to get "Interest Free Financing for a Year" here, a credit card there. It made it very easy to snowball in the wrong direction. Luckily, I now know the difference between good and bad debt and how each one affects the other and how having debt affects my life.

“Good” debt is defined as money owed for things that can help build wealth or increase income over time. “Bad” debt refers to consumer debt that does little to improve your financial outcome.

So what are some examples of "Good" debt?

A mortgage! - We all have to live somewhere and rent money is just lost money. Every time you make a payment on your mortgage, you build equity in your property. Equity is the difference in what you owe and what your home is worth. Let's say you owe $100,000 on your mortgage and your home is valued at $200,000. That means you have $100,000 in equity. Home equity can be used as a line of credit, much times with lower interest rates than taking out a loan or on credit cards. Careful though. If you default, your home is at stake.

Equity adds to your net worth! Another great thing about purchasing a home and obtaining a mortgage is, while you are making payments and building your equity each time you do, the value is most likely appreciating (gaining in value). So depending on your market (where your home is located), your home could potentially be worth an average of 4% more each year!!!

EXAMPLE: A home valued at $120,000 that appreciates 1.8% each year for the next 5 years would compute to a value of $131,195.86!! That's an additional $11,196 in equity/net worth in just 5 years!

Business loans - Getting a loan to start or expand a business can be a wise investment. Growing your business can help you grow your income. With careful planning, you can help to make sure that borrowing for your business is a calculated risk.

Student loans - Earning a college degree doesn't guarantee you'll get a job, but there's plenty of research showing that it can boost your earning power over time. Median earnings of bachelor's degree holders with full-time jobs are $24,600 higher than the median earnings of high school graduates with full-time jobs, according to 2017 research by the College Board.

Now, let's talk about "Bad" debt...

High-Interest Credit Cards - High interest rates, such as those greater than 20%, can make your debts more expensive. If you’re not making progress on your credit card debt, despite paying all you can monthly, that may be a sign you’re facing problematic credit card debt.

If you can keep your spending under control, try out the debt snowball method, where you pay off your smallest debts first. This method helped me eliminate all my bad debts I had acquired over the years.

Personal Loans - Taking on debt for expensive items like vacations, clothes, an ATV or anything that does not add to your financial wealth and that depreciates (goes down) in value over time can be an expensive habit and detrimental to your life and well-being.

Payday Loans - This is a very bad habit that can turn toxic quickly. With payday loan interest rates up to 300%, it makes this loan extremely unaffordable. This can create a debt cycle difficult to dig out of. Try borrowing from a friend or family member or, even better, ensure you have a "rainy day fund" set back for emergencies!

On the Fence - Car Loans - Most of us need a vehicle to get to where we need to go which makes this a good debt but... carful on this one. It's a fine line between good and bad debt. Brand new cars can depreciate 20% in value after just 1 year! After year 1, they lose about 10% each year after that. Instead of buying brand new, consider an older model. This equates to a lower monthly payment, lower insurance and tax costs. Another added debt to taking out a loan for your vehicle is that you are required to have full coverage which can get pricey on a brand new vehicle.

I have never owned a brand new vehicle and never will. It's too costly of a debt that eats into building a future of wealth. Plus, I'm sure as with many new purchases, the high of having the latest and greatest wears off quickly.

Managing debt responsibly helps you build a good credit history. Since your credit scores can be a factor in everything from renting an apartment to getting a job, a good credit score can open lots of doors. It's better to have no debt than to have bad debt—but having good debt and managing it wisely can be a smart financial move. Remember, even good debt can go bad if you take on more than you can afford. If your mortgage eats up half your salary, or you've taken out $200,000 in student loans to get a degree in a limited, not so popular field, that's not so good. To make good debt work for you, be sure to match your debt to your goals, keep your debt-to-income ratio under control, and never take on more debt than you can afford.

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