While debt is something that you want to limit as much as possible, owing money to another person or company is not always a bad thing. In some cases, borrowing money can help you grow a business, buy a home or make sure that you have transportation to school or work, or help manage debt. What are some factors that separate good debt from bad debt?
What Makes Debt Good?
A debt is worth taking on if there is a return on that investment at some point in the future. For instance, those who go to college may have to spend up to $100,000 or more to do so. However, their earning potential is generally higher than those who only have a high school diploma, which means that they can recoup that cost and then some.
Borrowing money to buy a home or an investment property may also be an example of a good debt. Homes generally appreciate in value, and you may be able to make a net profit each month depending on whether you are able to rent it.
Flipping homes may represent an effective method of making a profit even if you have to borrow to make the purchase. The key is that you want to manage your debt to ensure that you don’t advance yourself more than you can afford to repay.
What Makes a Debt Bad?
Bad debt is any debt that you can’t afford to repay or that doesn’t represent any sort of value going forward. For instance, putting your taxes on a credit card isn’t necessarily a good idea unless you have no other options. This is because the interest rate on a credit card is quite high while the debt cannot be discharged through bankruptcy.
Any debt that you cannot afford to repay is generally considered a bad debt because it could impact your finances today as well as in the long run. If you choose to continue making payments, the interest on the debt could actually cause it to grow over time. If you choose to stop making payments, you could be forced to file for bankruptcy. Doing so will lower your credit score and disqualify you from most loans for up to a year or longer.
Only You Know Your Situation
In some cases, what may typically be considered a bad debt may be the best option to maintain your standard of living. For example, putting your taxes on a credit card may be a good idea because it allows you to keep cash in your checking account to pay the rent that month.
In such a scenario, you don’t want to put yourself or your kids on the street when there are other options available to avoid that. However, it is critical that you figure out a way to pay all debts as quickly as possible to ensure that you aren’t trapped in a debt cycle.
If you are poised to put yourself in debt in the near future, make sure that you are aware of all the consequences of doing so. Read your loan documents to ensure that you understand the term, the amount of each payment and the interest rate. Doing so will also ensure that you understand any potential consequences for failing to make one or more payments.