Good vs Bad Debt
Is there such thing as “Good” and “Bad” debt?
You may have heard the terms “good debt” and “bad debt” used before. Certified Money Coach, TED Speaker, and author, Tammy Lally defines “’good’ debt is an investment of money that grows in value or generates long-term income” and “’bad’ debt works against you from the onset.” Americans take out loans and lines of credit to finance all kinds of purchases from weekly groceries to a new home. As a consumer, it’s important to understand the differences between these types of debt and how to use credit responsibly to maintain a good credit score and get approved for future loans and lines of credit.
Two examples of good debt include your mortgage and student loans.
- Mortgage Debt – when you finance a home, you are investing in an asset that is in most cases expected to increase over time. If you put down a 20% down payment or built at least 20% equity in your home, that’s even better. However, if you are not prepared to cover unexpected costs and poured everything you have into the down payment, this investment can be precarious. Today, stringent underwriting standards and responsible lending practices are enforced to protect borrowers from buying a home if they are not qualified to repay their mortgage debt.
- Student Loan Debt – most Americans go to college with the goal of getting a degree that helps them increase their earning potential. If you don’t finish your degree or look for work in a field where your degree does not apply, this good investment can quickly become a questionable one. When making the decision to take out student loans it’s important to also make a plan to pay them back.
Two examples of bad debt include credit card debt and long-term car loans.
- Credit Card Debt – credit cards have higher interest rates than other loans because they are intended to be used as “revolving credit.” Cover an expense and then pay it off within a reasonable amount of time. Using a credit card irresponsibly and overspending on expenses you will not be able to cover can quickly lead to insurmountable debt as interest piles up. If you are facing credit card debt, some credit card providers or credit counselors can work with you to establish achievable payment plans to reduce the long-term damage of credit card debt.
- Long-Term Car Loans – financing a new or used vehicle with a loan is common practice, but the type of loan you use for this purchase will affect you and your credit. The longer the term of the loan, the more interest you will pay over time. It’s also important to consider that unlike a home, a car will begin to depreciate as soon as you start driving it.
Your debt-to-income ratio is one of the most important factors when it comes to financing a home purchase or securing any other type of loan. If you have any questions about good or bad debt, and your debt-to-income ratio, please let me know.