I’d like to share this article I read on “Good Debt vs Bad Debt”.
Our goals are to eventually become debt free, if possible, but the careful use of debt can be a tremendous benefit. You may have heard the term “Good Debt” and wondered what that could mean so allow me to explain:
Good debt is considered to be funds that you borrow to purchase an appreciating asset or to garner a higher return elsewhere. Examples are real estate that rises in value over time, a business or investment venture or even a student loan to provide an education which will result in the borrower earning a higher income. Basically, it is using borrowed funds to invest in your future that will hold a greater return later. This is good debt.
Bad debt would be money you borrow to purchase a depreciating asset. Examples of these include vehicles, luxury items and other consumables that have little or no value over time and/or do not generate any revenue. These debts are almost always at a much higher interest rate than good debt. Make no mistake, this is bad debt!
Another way to look at good debt vs. bad debt is the type of debt, regardless of its purpose. If you were to invest in a business with a credit card debt that has a 23% interest rate then this would be considered bad debt as it is high rate, perhaps higher than your return, and has a very high repayment rate, putting you at risk of not being able to make the monthly payments. Perhaps this is an extreme example, but you get my point.
Let’s have a look at the types of debt individually:
Credit card debt is considered bad debt. Credit cards are not evil if they are used prudently and balances are not carried over but any long-term debt on credit cards is bad debt and your credit score will suffer as well.
Auto loans would be bad debt as vehicles depreciate very quickly. Sometimes the rates are not too bad, but those payments make it much harder to access good debt such as a mortgage.
Mortgages are considered good debt because real estate generally appreciates over time. You are also borrowing at a lower interest rate. Consolidating other bad debts that were perhaps taken during times of emergency (or perhaps bad choices) into this good debt is a prudent move.
Home Equity Lines of Credit, which are another type of mortgage, can be either good debt or bad debt depending upon what they are utilized for. I often see people only paying the interest only portion that is required every month or using these products for daily expenses. This would be a bad way to use a potentially good debt.
Tibor Bogdan & Associates
*Personal Real Estate Corporation
Sutton Showplace Realty