Debt can be a complicated concept. Although it’s worked it’s way into the lives of millions of Americans, it has not always been for the better. Debt that helps finance out education can lead to great improvements. Consumer debt, however, can often be described as bad debt, not gapped debt.
Differentiating Between Good Debt vs Bad Debt
The amount of debt is increasing in this country. This is largely due to the fact that credit is easier than ever to get.
In decades past, credit card companies carefully evaluated potential customers and only issued credit to the most responsible. Today issuers target people that charge more than they can afford and maintain a balance.
What makes debt so complicated is this: not all of it is bad.
Debt can be a great way to create wealth as well as a responsible and appealing credit history. On the other hand, debt can lead people down a path toward foreclosure and bankruptcy.
This article will discuss the differences between good debt and bad debt.
Good debt includes mortgages, schooling loans, real estate loans and business loans.
One way to understand the concept of good debt is to think of it as in investment. Any debt that creates wealth and income in the long run is a good thing.
The best example of this is a mortgage. A mortgage works for you because home values, on average, double every decade.
School loans are also good debt because they help you get a degree or certification that will enable you to earn a better income.
Good debt also includes any debt that’s tax deductible.
Another aspect of good debt is switching from high-interest debt to low-interest loans.
If you open a home equity line of credit with a 6% interest rate and switch over credit card debt that you’re currently paying 20% on, that’s good debt because you’re saving money. Any time you get rid of high interest rates in favor of a more affordable rate you’re creating good debt.
Bad debt is best thought of as something that decreases in value right away and has no potential to increase in value.
Bad debt includes credit cards, auto loans and store credit cards.
Purchasing anything like durable or disposable goods and not paying your balance completely is creating bad debt in your life and should always be avoided.
Keep in mind that when you pay for a car loan, for example, you’re acruing interest rate each month. Meanwhile, your car continues to lose value.
The Influence of Debt on Your Credit Score
The type and amount of debt you have affects your credit rating in a number of ways. You should always keep your debt-to-income ratio in mind when using credit and never let your personal debt go over 35% of your income.
Missing any payments on your debt can also negatively affect your credit rating.
Store credit cards are a major problem for many individuals. They offer a one-time, up-front savings of around 15% but charge extremely high interest rates between 23 and 29%. Many people don’t realize that all the savings they get from the discount are quickly eaten up by high interest rates.
Auto debt is another serious problem for many. While almost everyone needs a car, the cost is often higher than many can afford to pay at once. This leads to people purchasing a more expensive car than they require on credit. And this in turn creates a massive amount of bad debt that can be up to $70,000.
Turning Bad Debt Into Good Debt
The good news is you aren’t always stuck with bad debt. Turning your bad debt into good debt can be done in a number of ways.
For example, creating debt to trade an old car in for a small, fuel economic model saves money and can benefit you financially.
By far the best debt is mortgage debt because it builds a great deal of wealth over time.
On average, home prices have increased almost 7% per year over the last three decades. Borrowing to buy a home is a great investment.
According to David Bach, the CEO of Finish Rich Inc., renters in this country have an average net worth of $4,000. Home owners have an average net worth of $150,000.
As you can see, mortgage debt is the number one debt to acquire that will pay you back over time.
Putting Good Debt to Work for You
In summary, good debt is a must because it creates a positive credit history and works to pay back the individual over time.
The best debt for anyone to have is mortgage debt because it pays back the most, creating a large amount of wealth over the years of ownership. Bad debt, on the other hand, should generally be avoided.
Bad debt includes credit card debt and auto loans, both of which cost money each month for goods that continue to go down in value.
Understanding the impact these types of debt have on you and your credit history will help you make responsible choices if you’re willing to consider your choices carefully before making large or unnessary purchases.