Good Debt vs Bad Debt

If you’re one of the millions of Americans in debt, you might be surprised to learn that not all debt is bad debt.

When you’re in debt, it can feel like an endless struggle. Especially when you’re dealing with multiple kinds of debt, like home mortgages, student loans, auto loans, medical bills and credit card debt. Making payments on all these different types of debt can be difficult if not impossible. Making matters worse, most people don’t know which debts to start paying off first (if you have extra money to make more than minimum payments).

It’s an unfortunate fact that debt is a way of life in the U.S, with $137,063 average household debt in 2016. Almost every major purchase, financial milestone, or life event has a debt amount tacked onto it. And if you are not part of the 1%, you might spend years working to overcome your debt.

If you’re one of the millions of Americans in debt, you might be surprised to learn that not all debt is bad debt. In fact, some debts are useful if you want to make more money, buy a home, or improve your finances. Being able to identify the differences between good debt and bad debt could help you figure out which of your debts you need to worry about first, and what can wait for later.

What is ‘Good Debt’?

Any debt that helps you build wealth or create a better financial future is good debt. Good debt helps you find a higher-paying job, own rather than rent, and make more money for yourself. A few kinds of good debt include:

1) Mortgages

Even though it may take 15-30 years to pay off, a mortgage could be a good type of debt. Going from being a renter to a homeowner may be smart because the money you put towards your mortgage could go back into your pocket if you decide to sell your home. And if you pay off your mortgage and decide not to sell your home, you can put that money into savings or invest it for an even higher return.

2) Student Loans

Spending money on your education could help you make more money in the future. Even if it means going into debt, student loans often pay for themselves in the long run because of the new career opportunities they could enable. In fact, college degree holders could make up to 84% more money over their lifetime than people who only receive a high school diploma.

3) Small Business Loans

Putting money behind your small business idea could be a solid decision because the goal of any small business is to make more money. If you’re a hard worker and have a solid business plan, your small business loan could give you the capital you need to set yourself up for growth and ultimate financial success.

Other types of good debt include certain auto loans, rental property, and investments that should increase in value over time. But good debt isn’t always good for you, especially if you don’t have the cash to pay it off. Even if you take out a good debt, you need to make sure that you’re getting the most value possible.

For example, an auto loan could be a good debt if you need a car to get to work. But the type of car you get matters. Instead of diving into heavy debt for a sports car or high end model with all the bells and whistles, the smarter financial decision is to buy a car in your price range—even if that means it’s used.

When it comes to taking out a mortgage, small business loan, or student loan, it’s smart to be frugal. Remember: a good debt is only good if it fits your budget. Always think about what you can afford to spend each month on debt before you take out a new loan—otherwise you may end up having to take out a bad debt to cover the cost of a good one.

What is ‘Bad Debt’?

Generally, if you take out a debt on anything that will decrease in value over time, that debt is considered a bad debt. There are a few different ways to get into bad debt:

1) Credit Cards

One of the most common forms of bad debt is credit card debt. In 2016, American households that carried a credit card balance had an average credit card debt amount of $16,883. Though some consumers accumulate credit card debt buying things they don’t really need, America’s dependence on debt is also linked to stagnant household income and rising costs. Unfortunately, relying on credit cards to pay for essentials can be a slippery slope.

With average APRs hovering around 14% for many credit cards, credit card debt could end up costing you thousands in interest alone by them time you pay it off—making it one of the worst kinds of bad debt.

2) Personal Loans

Personal loans can be used for almost anything—from paying for a vacation or wedding to consolidating your credit card debt. While personal loans usually have lower rates than most credit cards, they can be used for items that will decrease in value over time. That’s why they are considered a bad debt.

One particularly dangerous way to use a personal loan is as a down payment on a home or auto loan. If you do this, you are essentially doubling the payments you need to make each month, which could land you even deeper into debt.

Even if you take out a personal loan to consolidate credit card debt at a lower rate, personal loans could end up harming more than they help. Unless you have a plan to pay off your debt for good, a personal loan doesn’t do much more than shuffle your money around. And worse yet, if you don’t stop using your credit cards after consolidating your debt into a personal loan, you could end up in even more debt than you had before.

3) Payday Loans

Borrowing in the short term could really hurt you over time. Payday loans usually charge you an additional dollar amount for every $100 dollars you need to borrow. Amounts range from $10-$30. But if you can’t pay within the given amount of time, you could get hit with additional fees. Since payday loans are one of the most expensive types of loans and there are harsh consequences if you can’t pay them back, they are considered bad debt.

You could get into bad debt for many different reasons. Sometimes, it’s because you are using credit for things you don’t really need. At other times, it’s because you have to use credit for a sudden expense that needs to be paid right away. But in most cases, you get into bad debt because that’s the only option.

Wages have remained stagnant over the past five years, but the cost of living has gone up. With no savings and nowhere to turn, many Americans get into bad debt because it’s the only way to get by. If you find yourself in a bad debt situation, there are a couple ways to deal with your money problems.

How to Deal with Bad Debt

The first step in dealing with bad debt is figuring out which of your debt is actually bad. After you pinpoint the credit card, personal loan, and payday loans that need to be eliminated, come up with a plan to pay if off as fast as you can.

If you have a lot of bad debt, a debt consolidation loan may not be your best option. Debt consolidation loans could end up being another form of bad debt if you maintain the spending habits that got you into debt in the first place. And since you have less time to pay off a debt consolidation loan, your payments will be a lot higher and add even more financial stress to your situation.

If you’re struggling with $15,000 or more in bad debt, like credit card debt, a better option could be debt settlement. Debt Relief companies offer an affordable program that could help you end your bad debt without the stress of high payments. With help, you could put your debt in the past a lot faster than making minimum payments, and for less than the cost of a debt consolidation loan.

To find out more about Debt Relief and how it could help you overcome bad debt without a loan, request a free debt consultation now. Click here.