Good Debt vs Bad Debt

Debt can be used for different purposes and can feature different payment terms. You can borrow money to buy a house, you can get a student loan, borrow to buy a car, use your credit card, get consumer loans, borrow to invest and a lot of other purposes. But what is good debt and what is bad debt?

Debt can hurt you by draining your finances and make you unhappy, or it can support you and increase your financial position and happiness. It all depends on what you want to use the money that you borrow for. This article will determine which major types of debt will hurt you and which will support you.

– The house mortgage

The house mortgage will usually help you buy your house. Not many people are rich enough to buy a house with cash. For most cases this will be debt that will help you – as long as you make sure you know the terms and don’t borrow more than you can afford to pay back. I advise you to make the down payment in cash, if at all possible, as the interest rate on a loan for a down payment is significantly higher than the interest rate on the mortgage.

– Student loans

I consider learning as a very important investment. If, at the time you want to go to college, you can’t afford it, I see student loans as a viable option. Be careful not to borrow too much compared to what you will be able to pay back when you get your first job. Having student loans for 20 years or even more can be a big drain on your finances and happiness.

– Loans to buy appliances, a car or similar

This is in the category “maybe”. It depends on the exact use of the money. If, for example, you need a car to go to work, borrowing money to buy a car will be advisable as it helps bring in your income. If, on the other hand, you borrow money to buy a very expensive car, I would consider it borrowing for consumption. It will no longer just be money you spend on something you need to bring you to work.

– Credit card debt

Credit card debt is definitely bad. You pay a high interest rate and you generally use the money to buy items you can’t afford right now. Pay back your credit card balance every month and don’t use it to obtain debt.

– Consumer loans

Consumer loans are usually better than credit card debt, as you don’t pay the same interest rate. The interest rate is often lower. However, I still consider it to be bad debt, as you use the loan to consume more than you can afford right now.

– Loans to invest the money

Borrowing money to invest is a risky proposition. It might be a good idea, but you have to be very careful and know what you are doing. If you borrow money to invest in your own company, you increase your exposure. If the company does not become successful you will not only have no income – you will also have to pay money back on the loan. If you use it to invest in, for example, shares through a credit line, it probably isn’t as good as you might think. Even if on average you will earn money, you increase your risk of losing everything dramatically. If the shares drop in value, you have to come up with more funds or sell your shares. I recommend staying away from credit lines to invest in shares.

The final thought

I am sure you can find more things to borrow money for, that I have not covered here. It is impossible to cover all the different types. Use the concepts presented in this article and you will have a guideline on what to do. My general rule is that loans you obtain to invest in your financial future are good, while loans you obtain to consume are bad for your personal finances.