Good Debt Versus Bad Debt

Debt is confusing. Some people say debt is important and can help your credit score, others say to avoid it all costs. With credit card offers and advertisements for credit scores constantly berating us, it seems nearly impossible to sift through what is a good idea and what could put us into debilitating debt. It can also be terrifying to think about the massive debt we would incur by buying a car, house, or going to school, mostly due to the mixed messages we receive on debt.

So how do we know when, how and why we’re supposed to have debt, and when is debt not the right way to go? The key to this question is knowing what good debt is versus bad debt, and trying to only accrue good debt from here on out.

Good debt

So, what is good debt? If you’re like the majority of people, that sentence sounds a bit like an oxymoron. Debt is something you want to avoid, right? Actually, on the contrary, some debt can help your credit score and increase your chances of getting good deals on loans in the future.

The key to understanding what good debt is, is to realise that certain debt actually helps you in the future, or provides an investment opportunity that will pay off at some point. We’ll go through a few examples of how to obtain good debt safely and effectively.

– Credit Cards

To be considered for low interest loans for pretty much anything, you’ll need some sort of credit history. One of the easiest ways to build up your history is by opening a credit card and by actually using it. Showing that you can maintain a credit card without going into too much debt and make your payments each month will up your credit score like crazy, and help your chances with getting a good loan.

Having a strong available credit to debt ratio is another reason to have a credit card with a decently large available credit. You should have significantly more credit available than the credit that you’ve used.

– Car Loans

Speaking of loans, a car loan is another example of good debt to have. Unless you have heaps of cash sitting around, you’ll probably be needing a loan when buying a car. This will result in a monthly payment that you need to pay on time unless you want to incur a potentially hefty late charge. The same will be true for a used vehicle, but you’ll most likely be financing your vehicle  through a third party source.

– Home Loans

Home loans can often be considered an investment, which counts as good debt. When you own a home, it can potentially grow in value, which will help you in the long run if you decide to sell it. Having a home loan will help you diversify your credit, along with giving you an opportunity to make monthly payments, which in turn helps your credit rating.

One key to ensuring the debt isn’t overwhelming is to make sure you can afford the monthly payment. Work with a mortgage broker before you even begin to look at houses to find out what you qualify for and what your monthly payments will be to see if they will fit in your budget.

If you already own a home, you might also benefit from refinancing your home. One of the biggest benefits of refinancing is that you may be able to lower your payments, which can potentially help you pay off your loan and get out of debt sooner.

– Small Business Loans

If you’re a small business owner or looking to become one, you will most likely be needing loans to get you started. Small business loans are also considered to be good debt because of the potential for profits in the long run. It’s a good idea to work with a specialised lender depending on the type of loan you need, such as a commercial vehicle finance specialist, so you can make sure you’re getting the best rates for your type of loan.  It may also be a good idea to talk with a small business accountant to understand how much debt your business can manage.

Bad debt

– Credit Cards

Okay, if you’ve been reading closely, you’ll see that credit cards are on the good debt and the bad debt list. This is mostly because of how precarious credit cards can be. If you miss a payment here and there, you’ll take a big hit on your credit rating, which can have an effect on future loans. It’s also easy to get overwhelmed by credit card debt, and to start relying on it as an income source versus an emergency source.

Interest rates are another huge reason why credit cards can end up being bad debt. If you don’t pay off your card each month and instead maintain a balance from month to month, you’re accruing a potentially high interest which is just more of a balance you’ll have to pay off each time.

If you’ve found a credit card with low or zero interest, such as a promotional offer, then you can feel free to take your time paying down the balance. Just make sure that you’ve paid it off in full before the interest starts back up again.

– Unaffordable Loans

This one should be blatantly obvious. Make sure that you know your own budget, and know exactly how much your monthly payment will be before you ever sign up for a loan. If you can’t afford the payment each month, your credit score will plummet and you may risk not being considered for a loan in the future.

– Cash advances

This is another no-brainer. Cash advances only prolong the inevitable of being low on funds. You are essentially putting yourself in deeper debt each time you take an advance, versus attempting to live within your means.

– Retail credit cards

These types of credit cards are usually a bad idea, unless you are confident you can pay off the balance each month. Most retail store credit cards have an incredibly high interest rate that will dramatically increase your balance each month if you aren’t paying it off.

Now with some basic tips in hand, you should have a better idea of what kind of debt is a good thing and when it can be a bad thing. If you take away anything, remember that most debt can be good debt if you can afford the payments or pay off the balance quickly, and if the debt is a long term investment or will have value in the long run.

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