Understand Good vs Bad Debt

Jason Piper |
When it comes to debt, some debt can be good. Before you go into debt, though, it's important to know the difference and know how to handle each type. Understanding debt will help you make better-informed financial decisions.
 
Good debt is typically used to invest in assets that appreciate, or gain value, over time, or provide long-term benefits. For example, student loans use to invest in education can lead to higher earning potential. Having a mortgage to own a home can provide stability and potential appreciation. Investing in a business can generate profit and growth.
 
Good debt can increase your net worth over time. If you go into debt for higher education and get a job in a field that has high earning potential, you will likely earn more than if you hadn't gotten that degree. Good debt, like mortgages, can provide tax benefits and deductions. As you pay off your good debt, your credit history will improve, enabling you to make big purchases and take out loans at a lower interest level.
 
Bad debt is often used for immediate consumption or non-appreciating assets. Credit card debt, which is used for everyday purchases or cash advances, usually comes with a high interest level. Payday loans, and car title loans fall into this category as well. The high interest rates accumulate quickly, becoming much more than you may have originally intended to borrow. This can lead to a cycle of debt as you borrow from another source to repay, and can damage your credit score.
 
A few key factors can help you decide whether a potential debt is good or bad. Look at the interest rate; lower interest rates generally indicate good debt. Longer repayment terms can make debt more manageable (this is partially why there is a 30-year repayment option on mortgages). Good debt is often associated with assets that appreciate over time. If the debt aligns with your long-term financial goals, it's likely a good debt.

By understanding the distinction between good and bad debt, you can make more informed financial decisions and work towards achieving your financial goals.

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