The material presented here is for educational purposes only, and is not intended to be used as financial, investment, or legal advice.
Good Debt vs. Bad Debt: Which Do You Have?
DEBT. While this one tiny word may cause your heart to flutter, there’s one important truth about debt that you need to know: It can actually be good for you.
Having the right debt and managing it responsibly can help you achieve big goals, build your credit and more! So, what separates good debt from bad? Here’s a breakdown:
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GOOD DEBT
How can taking on debt be a good thing? In order to build your credit, you’ll need to actually have credit — which means taking on some debt, even if you choose to pay it off right away. Lenders use your past debt history to determine your interest rate. Those with a high credit score and strong credit history will typically get the best (lowest) interest rates on loans and credit cards. A one-percent difference in your loan interest rate might not seem like much, but even a slightly lower rate could save you big bucks in the long run!
Watch this quick video to see the benefits of a lower rate.
Types of good debt can include:
Mortgage
A home loan can boost your credit score, provided you make monthly payments on time and finance an amount that you can handle even if your financial situation changes.
Home Equity or HELOC
This type of loan can be used to make improvements to your home, finance other purchases at a lower interest rate than you might get with other loan types, pay off debt and more! With a HELOC (home equity line of credit), you’ll be able to borrow funds as you need them.
Low-Interest Debt
You’ll pay less in the long run and, when you carry a balance, your interest payments will be more manageable.
Car Loans
If you choose to finance your ride rather than paying cash, you’ll build credit by paying on-time — and you can always refinance if you find a better deal!
Student Loans
Some of the larger lenders, like Sallie Mae, offer flexible payment plans that can make it easier to repay your debt.
BAD DEBT
Bad debt typically involves high interest rates, large loan amounts and/or less-trustworthy lenders. Be honest with yourself about what you can afford and look at how purchases impact your overall financial health. A credit card with a 20% interest rate might get you that new VR gaming system you’ve been dreaming about, but are you really willing to spend all of that extra money on something that could be outdated in a few years? Saving up the extra money and using your debit card for non-essentials like these might be a smarter move.
If you take on debt, you want to make sure that you can afford to pay off the full amount within a reasonable amount of time. Compare interest rates, terms (length of the loan) and the reputation of the lender to make sure that you’re getting the best deal for your situation.
Excessive Student Loans
Many families don’t have the cash to foot the entire bill for their child’s education, and the same goes for the students themselves. Student loans are a great way to help pay for college as long as you can comfortably pay back the money once you (or your child) graduates. Rather than relying on student loans alone, consider getting a part-time job (or having your child do so if they’re the one in school). Also contact your credit union, employer or community organizations to ask about local scholarships and grants.
“Fast Cash” Title Loans
These short-term installment loans can be risky because you have to pay them back quickly and the business can take possession of your vehicle if you default.
High-Interest Credit Cards
High-interest cards can cost you a mint if you regularly carry a balance; plus, it’s easier to go over your max limit if you don’t notice the interest charges piling on. Look for lower-interest credit card options with cash back or other rewards you’ll use.
Dealing with Bad Debt
The good news is that even if you do get into “bad” debt, there are ways to improve your situation. The first step is committing to pay down your bad debts before making any large purchases or taking on new debts. Many experts recommend the snowball method of debt payment, where you put all of your extra money towards your smallest debt first while making minimum payments on your larger debts.
But being financially healthy and stable isn’t just about getting out of debt. It’s also important to set yourself up for a smoother path in the future. These preventative measures can help you avoid getting yourself into a difficult financial situation again:
- Set a monthly budget and stick to it
- Save up for more expensive items
- Pay off credit card purchases quickly
Another important step is to build up your emergency fund so that you can pay for unexpected expenses, rather than putting them on credit.
While being completely debt-free might be your endgame, carrying “good” debt can actually help you reach other life goals. Just remember to consider which debts will help you in the long run and which ones might set you back.