The difference between good debt and bad debt
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For many people debt has become a curse. It’s a major source of stress for an ever-increasing number of consumers. But unless you’re independently rich, debt can be quite a necessity if you want to make a major purchase such as a home or an car.
Consumer debt is on the rise, and so are delinquencies. Increasingly more consumers are turning to credit counseling to get their debt in check. Even though restrictions on bankruptcy have been tightened, people are still filing in record numbers. These statistics paint a grim picture of debt, yet consumers are still using their credit cards and taking out loans.
The fact is that debt is not such a bad thing in and of itself. It can benefit us in getting the things we need and want. The issue comes with taking on too much debt. If we’re not careful, we can get in over our heads. And once we do, it becomes harder and harder to get out of debt.
By learning about debt and understanding what is an acceptable level of debt based on our income, we can steer clear of the debt trap all together. And if we’re already in too much debt, there are steps we can take to reduce it.
Good Debt vs. Bad Debt
Yes, there is such a thing as good debt. There are just a few types of debt that fall into this category, but it’s important to make the distinction. Some examples of good debt are:
Debt incurred to buy a home – Owning your own home has numerous benefits. But the reason that this is considered a good debt is because a home is an investment. As long as you keep up with the mortgage payments, you put yourself at an advantage by entering into debt because your home will normally appreciate in value over time.
Student loans – Getting a college education is a great investment as well. By earning a degree, you put yourself capable of enjoy better paychecks over your lifetime.
Debt associated with starting a business – Starting your own business can be a risky proposition, but it’s done with the intention of earning money. Some of the assets you purchase will depreciate rather than appreciating but for practical purposes, you can consider this a good debt.
There are numerous examples of bad debt. Here are a few:
Auto loans – Having a car is a necessity for many, but a car loan is still considered bad debt. Because your vehicle depreciates over time, you won’t be able to recover your investment when you’re ready to sell it.
Credit card debt – Although credit cards can feasibly be used to purchase things that appreciate, they are in general considered bad debt because of the types of things that are usually bought with them. The overwhelming majority of credit card purchases are things that lose value.
Most personal loans – Personal loans are often taken out to finance purchases of things such as appliances, furniture, and vacations. These are often things we need, and a vacation can even help us become more productive, allowing us to potentially earn more. But none of these things appreciate in value, so they are considered bad debt.
Just because a debt is a so-called good debt, that doesn’t mean it can’t get us into trouble. It’s vital to maintain our good debt at a manageable level. Lenders take our income into consideration when lending us money for this reason. But it’s also crucial that we look at our individual situations and not borrow more than we can comfortably repay.
On the flip side of the coin, bad debt is not always taboo. There’s no harm in taking on some bad debt to get the things we need and want. But the smart move to make is keep it to a minimum, only using it for things we really need.
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