Good Debt vs. Bad Debt: Know the Difference

Debt is something that none of us are fond of, but many of us know it well. The different types of debt vary, from a credit card to a mortgage, and you might be wondering if there really is any “good” in good debt while flipping through your bills and making payments. While it may come to a shock to some, there truly is a difference between the types of debt you may have.

The following are some of the key differences between the two main types of debt:

GOOD DEBT
Debt can be considered “good” if it has the potential to enhance your life. The debt can be a sensible investment if it has the chance to increase your net worth, generate income or improves your or your family’s life in the future. Though at first a loan would put you in the negative, good debt helps you overall and allows you to manage your finances more effectively to buy things you need and to prepare for any unexpected emergencies. The following examples show how debt can have a positive impact on your future financial success.

• Education/Student Loans. Generally, the more education someone has the greater their earning and hiring potential can be. This means there’s a higher chance of paying off the loan and being financially stable in the future.
  
  
• Business Loans. Even though there is always the risk the business will fail, if you’re successful you will be building for your future and the debt will be deemed worthy.
  
  
• Mortgage Loan. These loans can be classified as good debt since you’re able to earn equity and tax breaks as a homeowner. You can then sell your home for a profit, or you can generate income with this home by using it for a rental property.

BAD DEBT
Bad debt generally includes anything that has a very high interest which adds to the challenge of being able to pay back the debt. This also involves depreciating assets, which means it loses value quickly, and things that are more impulsive purchases than a necessity. There can be an array of debt which can hamper your future if you’re not careful. The following are just a few of these examples.

• Credit Cards. While it’s not a terrible thing to have one, unless you’re able to pay it off completely every month, it can quickly become “bad” debt with a higher interest rate.
  
  
• Quick Payday Loans. If you’re in a bind and need cash fast these loans sound too good to be true, and that’s typically because they are. Due to the staggering high interest rates attached to these types of loans, if you’re not careful you will end up in deeper debt then when you started.
  
  
• Personal Loans. These loans can depend on WHY you’re requesting the loan. If you’re taking out the loan to improve your house or your business, they can fall into the “good” debt area. However, taking out a personal loan for a vacation, clothes, and other consumables, can be considered bad debt since there’s no opportunity for future gain from the item you purchased. Understandably when times are hard and you’ve exhausted other options, you may need to consider this type of loan. When this happens, the key is to try to find the best interest rate possible.

The above are a few examples of the different types of loans and their benefits or consequences, but it’s important to remember one thing. At the end of the day debt itself isn’t necessarily ‘bad’. It greatly depends on the factors surrounding it, such as the individual’s financial situation or the necessity of the debt. It’s important to research and explore options before pursuing a loan, and to think carefully about the reason for the loan. Will it be of benefit to you five years from now? Ten years? Or is the purchase an impulse buy with no ability to benefit your life long-term. By criticizing your desire to purchase before obtaining a loan, you can protect your current finance condition, as well as your future financial status.

If you find your debt has become a struggle, because the bad outweighs the good, consider consulting with one of our certified credit union financial counselors at your local Dakotaland branch.  Now is the time to review your financial condition and explore your options for managing it. It is free, confidential, and the first step to your financial freedom.