Good Debt vs Bad Debt

Nearly all credit card debt is an example of “bad debt.” Bad debt is mostly unsecured debt that includes among it personal loans and credit card balances. But not all debt is bad debt. Quite the contrary some debt can actually help you.

Take education, for example. If you went to any of the colleges and universities around the country you are probably one of the millions of students who incurred some student loan debt. According to the National Center for Education Statistics more than 50% of college and university graduates have student loan debt. But this debt has probably helped you secure your current occupation or a recent promotion and has therefore increased your value since graduation. This is what is known as “good debt.”

The main difference between “good debt” and “bad debt” is how the debt is used. Using debt to increase your job-worth, your economic value (for example buying a house) or for investment purposes (purchasing high return stocks or bonds) compromises using debt in a good way. Why? Because “good debt” like education can get you a promotion or a job, a house will typically gain equity, high return stocks and bonds can typically be sold for more money than their original purchase price.

Bad debt typically does not increase your personal value, gain equity or increase your income. Rather it does just the opposite. Debt to purchase clothing, a car, electronics etc is all seen as “bad debt” because over time these things erode, breakdown or become obsolete thus decreasing in value. You end up paying more over time than the value of the item. For example the amount you spend on purchasing your car today will not be what the car is worth within mere moments of driving it off the lot. This debt can and should be limited.

When a person piles on mountains of “bad debt” it can significantly impact their FICO score. The three Credit Reporting Bureaus, Experian, Equifax and Transunion track all kinds of debt, good and bad. Revolving debt such as credit cards impact heavily on your FICO score. Failing to pay revolving debt, installment loans (such as your car) and personal loans on time can severely hinder your ability to purchase a home or secure a good interest rate on existing or potential “good debt” purchases.

In addition, higher interest rates can cost a consumer hundreds of thousands of dollars more in payments over his/her lifetime. The average amount of mortgage indebtedness is $69,227 according to an American Housing Survey conducted in 2001. At current interest rates a consumer with an excellent FICO score pays significantly less over time on his/her mortgage than a consumer with a poor one.

Knowing the difference between good debt and bad debt can help you make smarter and more informed choices. Using debt to increase your worth, be it educationally or financially, is a good move over all. Staying away from high interest credit cards, installment loans and personal loans can help you save money for more worthy credit purchases.