We all come to points in our life when we have to borrow money. It could be student loans to finance your education, mortgage to buy a house, or loan for your first vehicle. It could also be using credit cards to buy groceries.
Some debts are bad, while some obligations could be necessary – called good debts.
What is Good Debt?
Any debt that benefits you in the long run and in a positive way is called good Debt. It increases your net worth and will produce future returns.
While good debts are recommended, if managed poorly, it can turn to bad debts. Late payments and defaulting on good debts, for instance, will affect your credit score.
Here are typical examples of good debts:
Student loan debts: since the money from this Debt is to invest in your education and future, which will produce a future return, it is a good Debt. This is an investment that will pay off after graduation after getting a good job. The higher earning potential is the reward of going for student loan debts.
Mortgages: This is also a good debt attached to specific assets like a home. They come with low-interest rates, and payments can be managed monthly. The value of your home will likely increase in time, giving you a return on investment.
Business loans: in a way, a business loan is also a good debt as long as it is used to increase profits and scale.
Personal loans or car loans used to service medical bills can also be considered as a neutral or good debt. This, however, is a factor of the interest you pay.
What is bad Debt?
This is the opposite of a good Debt since they do not come with long term benefits. Besides, the interest rate borrowers pay makes bad debts pretty expensive.
Credit cards that come with a substantial annual percentage rate (APR) are bad debt. For instance, with a balance that requires you to pay 15, 20 percent or more in interest for things without long term value (buying grocery, dinner date), it is bad debt.
We can also classify alternative installment loans like title loans or payday loans as bad debts. They are convenient loans that are pretty expensive when you consider the high fees the lenders charge.
We can consider personal loans as neutral, a midway between good debts and bad debts. A personal loan to go on vacation to the Bahamas, for instance, is bad debt. A personal loan to renovate your house and increase the value is good debt.
Managing Good and Bad Debts
The only way to effectively manage good Debt like a mortgage or student loan is to pay (monthly) as at when required. You could also seek opportunities to limit the cost of borrowing. A simple way to save on interest and lower your monthly payment is to refinance student loans to a lower rate. You can also do this with a mortgage loan for a house.
If you have bad debts like car loans, credit card debts, and installment loans, your aim should be looking for ways to service the debts.
To get rid of credit card debts, we recommend considering a balance transfer, which makes the Debt pretty affordable. The best way to take care of credit card debt is to go for a balance transfer, which makes it pretty easy to service at an interest rate of 0%.
To take care of credit cards and other bad debts, consider debt consolidation. They are good, provided you can get one at a reasonable interest rate, and you do not go about creating extra bad Debt for yourself.
The only way to manage both good and bad Debt is to try and pay it off.
The fact that a debt is classified as a good debt is not a license to carry it. Also, make sure you can maintain minimum payment as defaulting will not help your credit score.
