All debts are the same. But, as the debts can have positive or negative consequences, they are commonly classified as good debt or bad debt. Choosing whether a debt is good or bad depends on an individual’s financial situation, including how much they can afford to lose. If debt raises your net worth or has some future value, it is good debt, whereas if debt does not increase your net worth and you do not have the cash to pay for it, it is bad debt.
Good debt improves your financial situation by helping you handle your finances more effectively, leverage your wealth, buy things you require, and handle unexpected emergencies, if any. Some examples of good debt include:
By borrowing money to buy a home, you expect the house’s value to be higher when paid off. Home equity lines of credit and home equity loans are loans in which a borrower uses their home as collateral. These are also considered good debts.
You are financing an education, leading to career options and potentially growing income. Also, some student loans have lower interest rates than other loan types, and the interest may also be tax-deductible.
The money you borrow to start your own business comes under good debt. Even though there are risks in starting your business, your chances of success are higher, leading to financial growth.
However, even student loans, mortgages, and business loans can be considered forms of bad debt in certain situations. Your good debt can turn bad if you borrow more money than you can repay. It can also be a problem if you finish your schooling but cannot find a job in your field if your home decreases in value or if your business does not bring expected income. Hence, debt is either good or bad, depending on the specific circumstances.
Debt is considered “bad” when it negatively affects credit scores. Bad debt is debt that you are incapable of repaying. It is also a debt used to finance something that does not return the investment. Hence, bad debt is a receivable that you cannot collect as your customers cannot pay the monetary amount they owe you. Some of the examples of bad debt include: –
If you plan to buy a car by borrowing money or taking a loan, look for car loans with low-interest rates. By the time you leave the vehicle, the vehicle is of less worth than when you bought it, making it a bad debt.
Credit cards with a high-interest rate are examples of bad debt. If you cannot pay your credit cards in full every month, interest payments can extend the debt, worsening the situation.
High-interest loans include payday loans or unsecured personal loans. These loans can be considered bad debt, as the high-interest payments are burdensome for the borrower to pay back.
How to Avoid Bad Debt
The debt we cannot afford to repay could damage our credit rating and worsen our financial situation. An excellent way to avoid bad debt is to avoid spending more than you can afford and avoid borrowing money without a repayment plan. You can even allow a portion of your monthly income to pay off your debts, and you ought to pay interest on the amounts you owe. However, good debt and bad debt can differ for each individual depending on their financial circumstances.
An automobile loan is a good example of this good or bad debt scenario. If you want a vehicle to get to your job, borrowing money to buy a car is good debt, as owning a car would allow you to get to work, quickly paving the way to your financial status. But this is not the case if you buy a luxury vehicle to get to your job if you are unable to afford one. If you cannot make the scheduled payments, purchasing an expensive car or accepting a car loan with expensive financing terms leads to more financial hardships.
Hence, before agreeing to any debt, be sure to ask these questions.
- Is this debt necessary?
- How can I pay off the debt?
- What is the most suitable plan to pay off the debt within the scheduled time frame?
- Is there a more reasonable option for me?
Therefore, if you stick to your monthly budget plan, keep lump sum money as emergency funds, pay your bills on time, restrict unwanted purchases, and do not borrow unaffordable money, you will be in a stronger financial position and be assured of avoiding bad debt problems. If you are still facing issues in your economic life, Dana MacRae – A licensed Insolvency Trustee, is there to help you provide solutions. Contact Dana MacRae at 1-800-665-9965 for a free and confidential consultation.