The Difference Between Good and Bad Debt

good debt vs bad debt(1)Although it is nearly impossible to live without incurring debt, not every dollar of debt is equal—and the difference does not lie principally with the amount of interest you are paying. Most forms of debt can be classified as either “good” or “bad” debt. Generally, good debt is money borrowed to purchase items or services you need and which appreciate in value. Bad debt is money borrowed to purchase items or services you merely want and which depreciate in value. To help you navigate the financial waters a little better, here are a few examples of ways people commonly collect debt and verdicts about their impact on your financial welfare.

Student Loans

student graduateSmart and responsible borrowing of student loans to further your education is the perfect example of debt that, if managed carefully over the long run, can have a greater payoff. For many people, a college degrees can open more doors to opportunities that they otherwise might have been without, and in turn allow them to pursue a career with more monetary benefits. In fact, a person with a master’s degree stands to make an average of 1.3 million more over the course of his life than a person with just a high school diploma. Also, various government programs like the Federal Stafford Loan or Pell Grant offer student loans at very low-interest or even interest-free rates.

Verdict: Good Debt.

Credit Cards

credit card debtCredit cards are the prime enabler of impulse purchases for things you don’t need. Every month, the average U.S. household carries $10,000 of credit card debt. Once people buy items with credit cards, they are enticed by the minimum monthly payments rather than paying off their full balance. This ultimately results in having to pay, for example, $100 for something that was only $50 to begin with. If you have an affinity for making impulse purchases, leave your credit cards home when shopping. Only use them on things you really need that cannot practically be paid for using cash. (Use our Credit Card Calculator to calculate how long it will take you to pay off your credit card and/or how much interest you are going to pay during that time.)

Verdict: Bad Debt.

Home Mortgage

new home checklistBuying a home with borrowed money falls into the “good” debt category, but can also easily fall into the “bad” debt category if you are not a scrupulous buyer. Many people today find themselves owing more money to their lending banks than their homes are actually worth.

By developing good credit, however, you can take out a mortgage with a manageable interest rate, which will provide you with a source of retirement money (not to mention a roof over your head).

Verdict: Good Debt.

Payday Loans

paydoan loan debt(1)Do not even think about it. Payday loans are the worst conceivable way to accumulate debt. With loan shark-like interest rates, payday loans can potentially put you in a hole as fast as they can take you out of one. It would be wiser to swallow your guilt and ask to borrow from your worst enemy.

Verdict: Bad Debt.

 

Health Care

healthcare debtThere’s no way around it: 60% of U.S. bankruptcies are due to unpaid medical expenses. As daunting as this is, what can you do? There is no amount of money not worth keeping yourself or a loved one alive. Money can be repaid; your lives cannot be renewed. To avoid costly medical bills, purchase a good health care policy. There are many inexpensive coverage options that are made available to college students.

Verdict: Good Debt.

 

A Last Word

Loans and credit cards can seem irresistible, especially when you are young and foolish and feel immune to financial disaster. But take note of the financial condition of most of the United States. Nearly an entire nation finds itself under a pile of debt it has no idea how to repay. And there is plenty of room for you under there. This does not mean you should avoid debt on the whole, just that you should use it as a tool to further your financial status rather than indulge your impulses.

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