Is there any such thing as “good debt”?
Coming from someone that has made conscious debt choices – I’m surprised by this too.
YES, there is good debt out there, or should I say – better than most.
Today, plan on learning about the different types of good debt vs. bad debt.
As an added element, I’ll give you ideas on ways to approach debt in order to think about it more strategically and less emotionally.
Good debt vs. Bad debt: Plan Your Approach
How does debt work?
Taking on debt is risky.
Essentially, you’re borrowing money that you promise to pay back at some point in time.
Having debt payments on an on-going basis without a plan is not ideal.
The best course of action is to have a plan whenever you decide to go into debt.
Consider these types of questions:
→ How much extra do you plan on paying each month?
→ Will you work to pay off the debt prior to maturity?
→ Are the payments going to leave you in the red if you lose one income source?
Think about all of this before signing on the bottom line.
Upside of Debt
Carrying debt has many downsides, but let’s glean one of the upsides of holding debt responsibly.
A credit score.
Sometimes it’s odd when you think about the power of this 3-digit number.
It seems absurd.
Take out debt, make payments each month (or in full), and watch your credit score trend upward.
In order to build credit, debt is incurred – but only if it makes sense.
Here’s how to makes sense.
→ Financing a house that can be reasonably afforded.
→ Charging normal purchases on credit cards that can be paid in full each month.
→ Taking out student loans for schooling, but aiming first for scholarships and subsidized student loans.
The severity varies and it’s not a reason AT ALL to take out more debt than you can pay.
As with anything, if you have the funds to make your purchases in cash – do it!
Buy your house, car, tuition, business outright with cash if you have the means AND if it fits in your overall financial picture.
Learn more about building and maintaining credit: A Guide To A 3-Digit Number
Downside of Debt
The downsides of debt are plentiful.
It can become a downward slope if you’re not careful.
To prove this point –
As I was writing this article, I saw a story on the Rachael Ray show that fits very well in this section.
This particular segment had a man in his early-30’s recounting a college story from his early-20’s.
He started with a full scholarship for his schooling.
It went downhill when he was offered a credit card on his college campus along with free pizza and a T-shirt.
Before he knew it, he had incurred ~$25k debt from buying a bunch of stuff on his credit card.
On top of this, he lost his scholarship due to decisions he made unrelated to the debt.
I could envision this event breaking a lot of people, but when his parents didn’t take him back and he was sleeping out of his car, it took him time, but he found his way – and he even wrote a book about it!
Good Debt (Better than most)
“Better than most” debt is acceptable when it can grow in value and/or generate income as a result.
If you ever want to buy a house, you’ll likely need to get a mortgage loan.
I don’t know about you, but I don’t have hundreds of thousands of dollars sitting around to buy a house.
Some people would argue, in that case – don’t buy a house.
I’m not one of those people.
If you can take out a mortgage loan and you’re responsible for making the payments, then it can prove to be monetarily better than renting (in many cases).
When you buy a house, you’re able to build equity* and when you sell the home, after fees, there’s a chance you’ll end up ahead. Though, this is not always the case.
*equity = (value of home – mortgage balance)
Alternatively, it’s a guarantee that when you rent an apartment/home from a landlord, there’s no chance that you will see that rent money again.
That being said, there is no “right way” when it comes to being a homeowner or a renter.
Whichever way you decide, know that owning a home is considered an acceptable debt in your overall financial picture.
In my situation, owning a home has proved to be an economically good decision. My husband and I financed our first home when we were in our early-20’s. Now, about 12 years later, this starter home is in line to become a rental property for excess cash flow in early retirement.
WAYS TO APPROACH DEBT
1→ Aim for 20% or more for a down payment. When you do this, it helps you think more logically about a home purchase that can otherwise be an emotional purchase for many of us.
2→ Stay within the monthly payment that is comfortable for you to pay – instead of opting for the mortgage balance that “you were approved for”.
For instance, if you get approved for a $400,000 mortgage, with a 20% down payment, the payments will be ~$2,000/month.
Gauge if that makes sense for your overall financial goals and adjust accordingly.
3→ If you want to pay off your mortgage fully – set up a plan. Use an amortization table to help you determine the effect of your extra payments.
An amortization table lists all of the periodic payments showing the principal and interest that makes up each and every payment. When you look at an amortization table you will notice that as the loan reaches maturity, the payment you make each month gets applied to principal in higher amounts than at the beginning of the loan.
Student Loan Debt
This type of debt is not as solid as the mortgage, statistically speaking.
Student loans are notorious for the number of debtors that default on them.
Even still, if you are seeking a worthwhile, profitable degree, then it’s likely an acceptable debt.
Nonetheless, there are responsible ways to take out debt for college (if you don’t have the means to pay outright).
For me, it was by choice to work and attend school full-time. My employer paid a portion of expenses and my household paid the remainder. In order to do this, I opted to attend community college for pre-requisite courses and attended an in-state college.
WAYS TO APPROACH DEBT
1→ Take classes at the community college, then transfer your credits to an in-state college which is significantly cheaper.
2→ Seek scholarships, buy used books, get an internship, and pay for as much of your tuition out-of-pocket as you can.
3→ Only take out student loans necessary for college expenses.
Debt is considered “bad” when it’s used irresponsibly to purchase depreciable assets.
A depreciable asset continually goes down in value and does not generate income.
Furthermore, excess interest that is paid on these debt sources takes away from building wealth.
Credit Card Debt
This type of debt is one of the most dangerous.
According to the Federal Reserve, as of March 2018, the revolving credit card balances of Americans hit $1.027 trillion.
As I mentioned previously, having revolving credit card debt is a slippery slope and can cause financial turmoil.
Since the barrier to own a credit card is low, it can adversely affect the lives of countless people.
WAYS TO APPROACH DEBT
1→ Stay away from revolving credit card debt by charging only what can be paid in full each month.
2→ Weigh the pros and cons of having a credit card. You may have “perks” for having a card, but does it outweigh potential interest that you may be paying?
3→ Take care of existing credit card debt by using a balance transfer card that is reduced or zero interest. If you’re struggling to pay off the debt, just keep paying increased amounts on the balance without accumulating more debt.
Car Loan Debt
It’s a known fact that new vehicles suffer a significant drop in value as soon as it’s driven off the lot.
Beyond this, you will pay higher insurance as the bank will require that you maintain full coverage during the life of the loan.
WAYS TO APPROACH DEBT
1→ Finance only the portion that you can’t pay outright.
2→ Get pre-approved for a loan at your local bank or with an online provider that will have competitive rates for auto loans.
3→ If you settle on getting a car loan, then plan on making additional payments to pay off the loan more quickly.
The loans in this category can be used for a variety of goods.
Personal loans that are offered to the masses are oftentimes considered “unsecured” – meaning there is no collateral needed.
Due to this, the interest rate tends to be higher since there is more risk to the lender of non-payment.
Much like credit cards, personal loans are considered a bad debt to carry due to the high-interest that is assessed.
WAYS TO APPROACH DEBT
1→ If you’re seeking a personal loan to consolidate debt, opt first for “secured” loans that have lower interest rates.
2→ Seriously consider the cost of financing items that are temporary.
Not all debt is created equal.
If you’re smart about your approach, debt can be used strategically to help you with your financial goals.
Want more debt resources? Check out: 10 Signs Debt Can Lead To Financial Problems
Read more about my mission HERE.
*As with all financial and investment decisions, consult a professional. Read disclaimer here.
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Are there other types of debt that you think warrant some discussion? Would you classify them as good debt vs. bad debt? Share your comments below!