You hear the word debt, and your mind immediately wanders to building wealth and success, right? Well, maybe not. Often when you hear “debt”, you think of the negative side of debt: credit card debt, debt collectors, or high interest rates.
But, is there such a thing as good debt? Yes! Not all debt is scary. Whether your debt is good or bad comes down to your intention. What do you plan to do with the item that you are buying for which you need to take on debt? What purpose does it serve, and what benefits will you receive from it in the future?
Before we begin exploring good and bad debt, it’s important to remember that not all debt will fit perfectly into these categories. Different types of debt may require different considerations depending on your personal circumstances.
Let’s explore some of the differences between good debt and bad debt, and which types of debt can contribute to your future success.
What is good debt?
Good debt helps you to build or create more wealth or more money in the future.
The key differentiator between debt that is good and debt that is bad is its purpose. What are you buying that is causing you to take on debt, and how will this purchase impact your future?
The three most common types of good debt are:
- Student loan debt
- Mortgage debt
- Car loan debt
Student loan debt
Higher education and the student loans associated with obtaining that education are often considered an investment in your future. By obtaining an undergraduate or graduate degree, you not only buy yourself the opportunity to learn more, but you also open doors to new employment opportunities. This investment in your future could lead you to a new or better job that could pay you more money as you progress in your career.
Student loans are considered good debt. You take out student loans to further your career opportunities. Therefore, these loans can be considered an investment in yourself and your future. Before you take out a student loan, be sure to understand the starting salary of the career you’re aspiring to go into.
Remember, student loans can only be considered good debt if you are making consistent and timely payments on the outstanding balance. Failure to make payments on your student loans can impact your credit score and future borrowing opportunities.
Buying a new home and taking on the mortgage that comes with it is a big decision. While there may be differing views on whether or not a home will always generate more money in the future, a mortgage can be considered good debt.
A new home may offer you and your family a new start or a new opportunity. Purchasing a home can be an investment in your family’s future. You could pay off the home and potentially pass the home down within your family for generations to come. Renting or reselling your home could also increase your wealth over time. The ability to own your own home could allow you to start a new side hustle from the comfort of your own home, give your family stability, or free you from increasing rental prices.
Car loan debt
A car loan could also be considered good debt. Similar to obtaining a mortgage to purchase a home, obtaining a loan to purchase a car may be the right option for you. While some people may consider a car loan to be bad debt, as the value of the car depreciates once it is driven off of the lot, the purchase of a car could bring you new opportunities that you may not have had the chance to experience without the car. Those new opportunities could be new employment, relationships, or connections that bring you changes or wealth in your future.
There are some benefits to having auto loan debt. Consistent and timely payment of your car loan contributes to your credit score. Diversifying your credit mix is an important factor of your credit score, and a car loan can help with that. Similar to student loans, if monthly payments aren’t made to a car loan in a timely fashion, your credit score could be impacted, and this could prohibit you from future borrowing opportunities.
Remember to also be mindful of the price of your new car. As with any big purchase, it’s important to stay within your budget in order to keep monthly payments low. A new car with a high price tag would no longer be a good form of debt. Purchasing a used car at a lower price can help you stay within your budget.
What is bad debt?
Bad debt is any debt obtained for a purchase that won’t increase in value over time or won’t generate future income. Typically, bad debt is any debt with a high interest rate that does not create future benefits. Two of the most common types of bad debt include:
- Credit card debt
- Debt for other consumables
Credit card debt
Credit card debt is bad debt. Debt from credit card usage is generally some of the worst debt, as it often has incredibly high interest rates and serves you no benefits in the future. When looking at the various types of debt you have, depending on the size and interest rates of your debt, you may want to consider paying off credit card debt first. Credit cards typically carry the highest interest rate of any debt, and will likely cost you more money in the future the longer you have it.
Debt for other consumables
Debt for other consumables such as personal items, clothing, or furniture, is bad debt. Unless that garment you’re purchasing is a one of a kind piece of clothing from the 1700’s worn by a queen, it’s unlikely to bring you any wealth in the future. Similar to credit card debt, debt for other consumables will likely have very high interest rates. Meaning, you are paying more money for the item the longer you carry the debt.
So, while it may seem important to buy the latest, most stylish shoes or sofa, if it’s requiring you to take on debt, it’s probably not worth it.
Not all good debt is good for you
It’s important to keep in mind, that while certain types of debt can be considered good, too much of a good thing can also be harmful.
For example, if you’re taking out a mortgage, it’s important to consider your monthly payment and what you can afford. While a mortgage can be good debt, if the monthly mortgage payment is outside of what you can actually afford each month and is causing you to spend outside of your means, then this can quickly become bad debt. Remembering to keep your monthly payments on mortgages, car loans, and student loans within your personal spending limits will help you manage your good debt.
In conclusion, not all debt is bad when you spend within your means. If the debt you have will create more wealth or money in the future, and it’s in your budget, then this could be good debt for you.