Good Debt vs. Bad Debt: What’s the Difference?

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The distinction between bad debt and bad debt can be made clearer depending on what is purchased.

Highlights

  • Good debt is an investment that will grow in value or generate income over the long term.
  • Bad debts are incurred to buy things that lose value and don’t generate long-term income.

Good debt benefits your financial future, while bad debt hurts it. The distinction between bad debt and bad debt can be made clearer depending on what is purchased. At the macro level, governments as well as at the micro level most households are in debt. Is it true that no debt is good debt?

What is good debt?

Good debts are those that pay dividends in the future. These are investments that will increase in value or generate income over the long term. Low interest debt can also be good debt. Some examples of good debt are student loans, mortgages, and small business loans.

Student loans for college education are a good example of good debt. These generally have a low rate of interest compared to other types of debt. It promises to increase an individual’s worth and increase their future income.

Take out a mortgage buying a house is also good debt. Home loans are generally long term loans, have a lower rate than others, and the interest is tax deductible. The granting of a mortgage loan leaves the possibility for an individual to invest in other portfolios with low monthly loan repayments. This is keeping in mind that the value of the mortgage increases over time in the market.

Home equity loans are also considered good debt because of the lower interest rates which depend on the appraised value of the house. The lender uses your home as collateral.

What is a bad debt?

Bad debt is where the borrower takes money from the future to spend something today. He is hired to buy things that lose value and do not generate income in the long run. Bad debts also carry a high interest rate. Using a credit card to watch a concert is bad debt. Examples include payday loans, credit cards, auto loans. Bad debts are usually the ones that stifle the desire for instant gratification.

Cash advance loans or payday loans require borrowers to pay fees and interest incurred over time. Failure to repay the amount by the next payday, still acquires processing costs.

Credit card used for non-essential purchases involving high interest rates are generally bad debt.

Auto loans usually come in gray areas. While a person may need a car to get to work, new cars depreciate as soon as they are on the road. Paying interest on an asset whose value is depreciating is therefore an example of bad debt because it is detrimental to its financial future. Another option is to go for well-maintained used vehicles that will not drop in value suddenly.

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