The Difference between Bad Debt and Good Debt

“Neither a borrower nor a lender be,” wrote Shakespeare and the bard’s wisdom is one that would benefit many people today. As debts rise and defaults and bankruptcy dominate the news, the examples of the misuse of debt are everywhere. But not all debt is created equal and not all debt is bad. When used wisely (and sparingly) debt can help you improve yourself or your situation and end up being an investment in the future.

Bad Debts
Bad debt usually:
Has a high interest rate and high fees
Allows you to live beyond your means
Is unsecured or tied to depreciating assets
Is quick and easy to access

Credit Card Debt
Credit cards are one of the easiest debt traps one can fall into. According to the Federal Reserve, the median credit card debt for those who carry a balance is $2,200. Often, this debt comes with high costs and fees which do nothing more than transfer your hard earned wealth into the pocket of the credit card companies.

Payday Loans
You see them in strip malls and street corners: friendly payday lenders happy to hand you a few bucks until payday. But these friendly storefronts house legal loan sharks that prey on those in need with high fees and interest rates as high as 400 percent.

Long Term Auto Loans
You never want to find your car upside down and the same goes for your auto loan. Automobiles, unlike most homes, will lose value as they get older. This puts anyone with a car loan in the awkward position of paying down a debt on an asset that is worth less each day. Take too long to pay it off and you could find yourself owing more for your car or truck than it’s worth.

Dealers will try to stretch things out over five, six, or even seven years in order to get the payments low enough to make the car seem cheaper. In reality, long term auto loans pile on the interest and set you up for financial ruin in the long run. If you can’t pay it off in three years, you probably can’t afford it.

Good Debts
Good debt characteristics include:

Improving your situation
Saving for the future
Reducing your taxes
Association with appreciating assets

Home Mortgage
Owning a home is one of the biggest debts an individual will ever take on but, when used wisely, it can be one of the fastest ways to improve a lifestyle and build long-term wealth.

Everyone needs a roof over their head and for most people keeping that roof there costs money. Investing in a home and repurposing a rental payment to a mortgage payment can redirect money towards building equity in a tangible asset with incredible long-term appreciation potential.

Student Loans
Education is an investment in you. Student loan debt is a personal investment to better your career prospects and earning potential. Plus, the interest on some student loans can be used as a tax deduction for up to five years after you leave school.

Debt is what you make of it. You can use it to live beyond your means and become a slave to high interest rates and minimum payments or you can use it as an investment in your future to help improve your career prospects and living situation. You owe it to yourself to use it wisely.