Good debt vs bad debt is a debate a lot of people have been talking about for quite some time now. The on-going health crisis made people think about their debt situation more. As economies were affected and businesses forced to adjust, a lot of people found themselves strapped for cash. This meant that they had to quickly manage whatever money they had under their name.
While doing that, you had to deal with the fact that you have debt obligations every month. You suddenly find yourself trying to classify your debt accounts to help you prioritize payments. It feels like you are putting every single item under the microscope. This is important if you want to get through the crisis with your finances intact.
You need to keep in mind that not all debt is created equal which is the reason why you need to understand good debt vs bad debt. It will help you choose what debt you take on or how to make the most of the financial decisions you need to make. Here are some of the most common debt
Student loans
When you start to talk about good debt vs bad debt, student loans will always come up. For the most part, many people would quickly point out that borrowing money to pay for the cost of attendance in college is worth it. A lot of evidence points to the fact that a college education can help improve the chances of getting better career options later in life.
This is one of the reasons why people would be quick to label student loans as good debt. Even if Forbes shares that the student loan in 2020 has reached about $1.56 trillion. And for the most part, it is because it helps you improve your earning potential for the future. A degree can open a lot of professional opportunities for you when you graduate. But this does not give you the green light to borrow as much as you can for college or even for postgraduate studies.
A good rule of thumb is to try and limit the amount you borrow within your expected annual salary from your career choice. Considering that your income will increase as you go along, this rule helps you stay ahead of interest payments. Borrowing too much could hinder you from enjoying and actually setting money aside from your paycheck.
Mortgage loan
The debate on good debt vs bad debt almost always comes to an agreement when it comes to mortgage loans. A lot of people usually agree that a house loan is a perfect example of good debt. The house in itself is an investment and every payment you make increases your equity on the house. The value of your asset adds a lot to your net worth.
When you take out a mortgage loan, it could very well be your biggest debt amount under your name. This is easily a six-figure loan you are taking out to buy a house. But the reason it is classified as good debt by a lot of people is that equity slowly transfers from your lender over to you. When you finally pay off the loan, your lender lifts their lien on the property and it is all yours.
But there are times when people choose to buy a house that way over their budget. You might think that your monthly income can cover the payment for the house but it is not that simple. This line of thinking could make you overlook other financial obligations you have at home. Make sure that after your house payment, you are still left with enough to cover for your other needs and future plans.
Business loan
Do you have a business idea you want to see take off in the near future? For the most part, one of the biggest challenges when it comes to putting up a business is putting up the start-up costs you will incur. This amount depends on the business idea and plan that you have. Even if technology has made it easier for people to start up at a minimal cost, you will still need funds to get your ideas off the ground.
This is where a business loan comes in to help. As the name suggests, it is a loan you take out to start your business. From that idea alone, it can help you decide the type of debt it is. When you start to think about good debt vs bad debt, business loans can easily be a valuable type of loan. But it is not always that straightforward.
Much like other loan types, you need to make sure that you only borrow what you need. Taking out more than what your business requires will only put you at a disadvantage. Saving up for your business will also lower the amount you need to borrow. At the onset, this is a good type of debt but how you use it will determine its real value to your finances and long term goals.
Car loan
When talking about good debt vs bad debt, depreciating assets usually is a clear indication that you are dealing with the bad kind. And one perfect example of that is a car loan. There is no question that buying a brand new car is a questionable investment for a lot of people. This is because once you drive off your new car from the dealership, its value starts to plummet. All while you are left paying for the full price for years to come. CNBC shares that the average amount borrowed by Americans in the middle of the year for car loans averaged over $33,000.
This is the main reason why buying second-hand vehicles makes a lot of financial sense. Of course, you need to balance that with reliability and safety. But if it can get you to where you need to be, then it serves its purpose. Remember that if you are buying a car just to impress people, you are only hurting your chances of reaching your financial goals.
There could be times when you actually need a new vehicle may be for work or business. If you are running a contracting business and your truck keeps on breaking down making you late for meetings or projects, then you need a new truck. It does not mean you buy the top of the line model especially if you cannot afford it. But it might be a good idea to buy a new vehicle to help you improve your business.
Credit card debt
Your credit card activity plays a big part in the debate between good debt vs bad debt. You might be quick to point out that credit card debt is bad debt. But much like the other types of debt, the way you use your credit card defines what type of debt it is for you. There is so much more with your credit card than you might think.
If you use your credit cards to help you manage your budget better, then that debt amount can be considered a good one. You make use of the statements to help you monitor your spending. You also use the rewards to get the most out of every single expense. But if you keep using your card to give in to your wants, you could easily end up in debt. This then becomes a bad debt you have to address quickly.
Good debt vs bad debt is a hot topic especially now where a lot of people are trying to manage their finances while going through a health crisis. It is true that borrowing money, and essentially taking on debt is usually a necessary step to reach your financial goals. The intention is not enough to classify a debt obligation, it is how you manage it that counts.
