Separating Good Debt from Bad Debt

Not all debt is bad. Whether your debt is good or bad depends on the type of debt, the reason you owe it, and whether you can afford to repay it. When used the right way, debt can help you manage your finances more effectively, leverage your wealth, buy things you need and handle emergencies. But if you’re not careful, debt can have a negative impact on your finances and destroy your dreams.

Debt can be positive by:

  • Building your family’s net worth – the difference between the current value of your assets and the amount of debt you owe. A mortgage is a perfect example. Good debt is even better debt when the value of the asset you finance increases over time.
  • Buying something that will save your family money for years to come. For example, investing in energy saving gadgets.
  • Purchasing something important to your life that you could never afford to buy if you had to pay with cash. For example a car loan or a mortgage.
  • Investing in yourself in order to increase your earning potential. For example returning to college or to upgrade your skills so that you can make more money in your current field of work or move into a more lucrative career. Student loans are a common example of its kind of debt.
  • Paying for an unexpected emergency when you don’t have the cash to cover it. For example, your car breaks down; your child gets sick and needs urgent, expensive medical attention.

Debt can be negative by:

  • You go into debt to buy nonessential goods or services that do not increase your wealth and have no lasting value. The longer you take to repay the debt and the higher the interest rate on the debt, the worse the debt.
  • Credit card debt is not bad if you pay it in full as soon as you receive your statement, or if you pay the debt in full within a few months and you don’t spend more on the card until you’ve paid off the outstanding balance on your account.
  • Secure the debt with your home or with another asset you don’t want to lose when you’re not sure that you can afford to repay the debt.
  • Have a high interest rate and make low monthly payments.
  • Borrow money from dangerous lender such as loan sharks.
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