Like the ultimate battle between good and evil, good debt and bad debt are worthy, yet often confusing opponents. Although “debt” has a bad connotation, there is actually a thing such as good debt, which can help build a strong credit history.
A strong credit score is imperative for nearly anything and everything. When you are purchasing a house, car, opening a credit line, or even purchasing a cell phone, the retailer or bank needs to trust that you know how to handle money. Without a history of paying, or more accurately repaying “good debt,” financial institutions have nothing to base your creditability upon.
Good debt is usually established in a few different ways. The first way to establish good credit is to have a revolving payment each month that you pay by the due date and in entirety. Some examples of revolving payments that generally don’t reflect negatively on your credit score are a mortgage payment or car loan as long as you are not living above your means. In actuality, proving that you can make these payments each month is an asset.
Another “good debt” if, and I stress IF you pay it off each month and don’t have a large balance is a credit card. The common mistake people make with credit cards thus lumping them into the “bad debt” category is they associate these credit lines as free money and treat the balance as a balance, versus a monthly payment. If you use a credit card, and keep it open for at least seven years making all your payments on time, it will actually benefit your credit history. The trick is to pay off your card to a zero balance each month.
Bad debt is generally everything else you owe. The credit card I discussed above is normally put into this category because most people do not pay their bills in entirety each month. Credit card’s interest rates are extremely high and a revolving balance is a red flag on your credit report. When creditors see a high balance continually on your report, they assume that you are living beyond your means.
Another debt that can edge into the “bad” category is school loans. Although they seem like a good idea, most banks encourage new students to take out larger loans than they need. Teenagers just entering college generally don’t have the strong money managing skills and think of these loans as free money. Instead of skating by on as little as possible, they take out enormous loans with high interest rates thus falling further and further behind.
In general, debt that constitutes anything above what you can afford each month is not good. Before taking out any loans or swiping your credit card, second-guess what and how much you can afford. By analyzing your spending, you can make your money, and your debt, work to your advantage.