Dealing with Debt 2 - Good Debt vs. Bad Debt

by: David Jackson

Yes, there is such a thing as good debt. There are only a few types of debt that fall into this category, but it’s important to make the distinction. Some examples of good debt are:

* Debt incurred to buy a home Avoid Foreclosure – Owning your own home has numerous benefits. But the reason that this is considered a good debt is because a home is an investment. It gains value instead of losing it, so you’re putting yourself at an advantage by going into debt as long as you keep your payments current.

* Student loans – Getting a college education is a good investment as well. By earning a degree, you put yourself in a position to earn more money over your lifetime.

* Debt associated with starting a business – Starting your own business can be a risky proposition, but it’s done with the intention of earning money. However, some of the assets you purchase will depreciate rather than appreciating. But for practical purposes, you can consider this a good debt.

There are lots of examples of bad debt. Here are a few:

* Auto loans – Having a car is a necessity for many, but a car loan is still considered bad debt. An automobile loses value over time rather than gaining it, so when it’s time to sell or trade you will not recover your investment.

* Credit card debt – Although credit cards can feasibly be used to purchase things that appreciate, they are in general considered bad debt because of the types of things that are usually bought with them. The overwhelming majority of credit card purchases are things that lose value.

* Most personal loans – Personal loans are often taken out to finance purchases of things such as appliances, furniture, and vacations.

These are often things we need, and a vacation can even help us become more productive, allowing us to potentially earn more. But none of these things appreciate in value, so they are considered bad debt. Just because a debt is a so-called good debt, that doesn’t mean it can’t get us into trouble.

It’s important to keep our good debt at a manageable level. Lenders take our income into consideration when lending us money for this reason. But it’s also crucial that we look at our individual situations and not borrow more than we can comfortably pay back. On the other side of the coin, bad debt is not necessarily taboo. There’s no harm in taking on some bad debt to get the things we need and want. But the smart thing to do is keep it to a minimum, only using it for things we really need.