Good Debt vs. Bad Debt: Things to Know

Millions of people stress over their finances in America —  which isn’t surprising because the average household in the United States owes over $100,000 in combined student loans, mortgages, credit card debts, and more.

Not all debt is inherently bad for you or your financial situation. A mortgage, for example, can be good or a healthy amount of debt

While being conscientious about money can help you make better financial decisions, not all debt is bad and it definitely shouldn’t keep you awake at night. Some debts are beneficial to your credit history and help you reach your financial goals. Learn more about good debt vs. bad debt when you read on today.

Difference Between Types

The main difference between good and bad debt is whether it increases your net worth or has any future value. If it does, then it’s good debt. These types of debt include student loans and property loans because there is a measurable value to the money you borrowed.

How Much is Too Much

Even though some debt can be good, there is still a possibility that you owe too much. You should carefully track your debt-to-income ratio to ensure you’re not overextending your finances and hurting your credit score. Compare your net income with your monthly bills to make sure you aren’t spending over 45% on your debts. These should include mortgage payments, car payments, credit card purchases, and other major bills.

The reason spending too much paying off your debts could be trouble is because it looks bad to potential lenders. They think you aren’t reliable because there are so many other debts vying for your attention. Even if all your debts are considered good debts instead of bad debts, they could still be a problem.

Examples of Good Debt

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Housing is usually seen as an investment when you finance or purchase your home

One of the best forms of debt includes a mortgage. It allows you to leverage your wealth and buy things you need — whether it’s your monthly groceries or an unforeseen medical emergency. Why is a mortgage considered a good debt and not bad debt? Well, generally housing prices have increased by an average of 6% from the 60s to the early 2000s. 

While the recession burst the housing bubble a few years later, and threw people into a tailspin, the housing market tends to recover because everyone will always need housing. Since then, home value has increased by about 7% per year and has continued to do so since 2012. Many people plan on their increasing home value and to eventually sell their place, double (or triple) their money, and live off of what they made on selling, as their retirement.

Other examples of debt that are generally considered good include:

  • Home equity loans
  • Student loans
  • Small business loans

Examples of Bad Debt

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Credit card debt can be easy to get into and difficult to get out of with steep interest rates

Anything that depreciates in value after you’ve bought it is considered bad debt. Some of life’s basic necessities — from clothes and cars to televisions and computers — are considered bad debt. If you can’t pay cash for them, you might not want to buy them.

In fact, credit cards are among the worst kinds of debt you could have because the high interest rates can be extremely steep. You might be paying 3-5% on a mortgage or student loan, but credit cards have interest rates that range from as low as 13% to as much as 23%. These numbers are variable and change depending on your credit score and perceived reliability. Regardless of your interest rate, credit cards and debt are linked because just one late payment negatively impacts you financially.

Is Bad Debt Really That Bad?

Just because they can lead to bad debt doesn’t mean you should never have a credit card. It is just important to repay your debts with high interest on time. Some other examples of debts that can turn into bad debt if you don’t repay them promptly include:

  • Auto repayment loans
  • Payday loans
  • Installment loans

Knowing more about good debt vs. bad debt can help you make the best financial decisions for you and your family. Have questions about how payday or installment loans can work for you? Reach out to us today to learn more.

These articles contain opinions from the Cash Factory Team.  You should always check with your financial experts before making decisions on your financial future.

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