What are some examples of good debt compared to bad debt? Is there such a thing as “good debt”? The truth is that any debt is something that is a burden and that we tend to take on far too easily. But that being said, some debt is worth it, while some debt is just simply ripping you off and setting you back further financially.
All of this is speculation and of course I need to let you know that I’m not a financial advisor and this isn’t financial advice. With that being said, here we go. Let’s start with good debt.
Good Debt
Typically, there are only a few types that are considered “good debt”. This would include mortgages, student loans, business loans, and possibly consolidation loans. That’s pretty much it.
Mortgages
Mortgages are property that you are buying that will likely increase in value over time, and as you pay it down you are “building equity”, therefore, this puts it under the category of “good debt.
Of course like anything in life, there is risk involved when purchasing a home, whether as a primary residence or as an investor.
Certain things become important. Buying at the right time is probably the main thing to consider. In other words, had you bought right before the market crashed this may have been a bad investment. While buying right after means you likely bought at a more opportune time. This can be the difference between a good investment and a poor investment.
Obviously, there are more factors here to consider. Is your house worth what you’re paying for it? This depends on a lot of factors but that’s the main question that needs to be answered. You need to make sure you’re investing in quality real estate and that there aren’t hidden problems with the property you are buying. Assuming those things are in order though, timing is what matters most.
Someone purchasing at the wrong time may actually end up in a situation where this could be considered “bad debt”. Some examples would be owing more than what your house is worth, or just the fact that had you waited for the right time you would be up on your investment X amount more. Timing is everything.
Overall, though, purchasing real estate is considered to be “good debt”. Just make sure you don’t get in over your head when buying.
Student Loans
This one is really a toss-up. The argument for going to college is that by getting a degree you’re setting yourself up to make about a million dollars more in your lifetime than a non-college graduate. But is it that simple?
Correlation doesn’t equal causation. That’s the bottom line when looking at these numbers and saying maybe they are skewed quite a bit.
That being said, if you’re taking out student loan debt that will lead you to a high enough paying job that is worth it, then this makes it “good debt”.
The problem is that close to half of college graduates aren’t even using their college degrees. You see how this could very well end up actually being bad debt right? And that is the case for a lot of college graduates. Their college degree is more or less worthless, meanwhile, they are stuck with tens of thousands of dollars in student debt.
Again, buyer beware. Don’t fall for this blanket idea that student loan debt is “good debt”. It can be, but only if taken on with extreme precaution and a well-defined end goal.
Personally, I would gladly give my degree back for the student loan debt I still have, hands down! And I know many others that feel the same.
The insane thing about student loans is that they will give them out to an 18-year-old who is likely to spend the next 2 to 4 years binge drinking while someone the same age with a complete focus could never get a business loan with the same qualifications. Which leads us to that.
Business Loans
This is another debt that could be considered “good debt”. That being said, these can be boom or bust. I mean at the end of the day if your business or business idea fails then it isn’t worth the debt. On the other hand, if this leads you to a lucrative business that takes off then obviously this is a “good loan” that is worth the investment.
Like the other debts listed in this category, it obviously takes a well-defined goal for this debt to be worth it. Personally, this is my favorite type of “good debt” because I’m an entrepreneur at heart.
But again, that doesn’t mean you should jump into debt without considering all possibilities. Taking on any kind of debt should require serious contemplation going over the pros and cons and weighing things out. If you do that then this can be good debt.
Now, there are an endless amount of possibilities that can fall under this category, whether it’s funds for a brick and mortar business, an online business, or even using margin debt to purchase stocks.
I would actually consider margin debt in a sense to be a business loan. If you’re using borrowed money to make money then that qualifies here.
Taking out this type of debt obviously highly depends on timing. Taking out a loan for a more traditional business obviously may rely some on timing but is probably more dependent on focus and hard work…as well as some luck to go along with it (like anything in life).
Consolidation Loans
If you’re able to take debt you already have and put it into a lower interest rate where you’re going to pay less interest/fees then this can be considered “good debt”. Considering this is basically just taking debt you already have and lowering the overall interest you pay. So in a sense, this isn’t really additional debt.
Like other debt in this category, it should be taken on with a bit of caution. If you take several small loans and place them into one larger loan is it really going to save you money? That is the question, if you have a lower interest rate but aren’t paying it off quicker then this could actually work against you.
For example, if you have several loans and could pay a couple of them off in less than a year and then take that amount you were paying monthly and then apply it to other debt then doing a consolidation loan may actually set you back, especially if there are fees involved.
Instead of taking out a consolidation loan would it make sense to just buckle down and pay off your debt? It depends, but if you’re unable to pay off any loans to take on this “debt snowball” approach any time soon then consolidating for a lower interest rate could be a good way to go. This would then be considered good debt.
Bad Debt
Cars/Automobiles
This is probably the most common item that is abused by most people. We tend to take out car loans we have no business taking out. Raise hands if you’re one of them. I definitely am (or was).
Taking out a car loan means you are likely taking out something that is going to depreciate faster than you pay off your loan. Almost every time. Now, if you can break even and sell your car for what you owe then you’re doing fantastic. Forget about actually making money and getting a positive return from selling a car you bought from a dealership. You may as well play the lottery.
But these are things we see others all around us doing every day and we just think of it as normal. It’s completely normal to take out a car payment. Everyone does it. Isn’t there some phrase about doing what everyone else does…?? I can’t think of it…anyways.
The point is that taking out a car loan is “bad debt”. When you take out a car loan it isn’t to say it can’t be useful. I mean people need a car to get them places. The fact of the matter is that 9/10 times people take out more debt than they should here.
If you’re taking out a loan that is going to take you years to payoff then forget the bells and whistles, get an A to B vehicle. Take out what you need, not what you want.
Credit Cards
Credit cards are considered bad debt, for obvious reasons. These tend to have higher interest rates than traditional loans.
Now granted, if you’re someone that is using a credit card and paying it off in full each month just to get the points or airline miles or whatever, then that’s fine.
If you’re doing that then you’re not really carrying this as debt. Credit card debt where you carry a balance and pay interest/fees is absolutely bad debt though. This should be rather straightforward.
Payday Loans/Personal Loans
These tend to fall under the same category as credit cards because they are more likely to come with a high interest rate. In fact, the APR on these can be far worse than even credit cards.
Some can even have APRs over 600%! This is because they tend to charge fees on top of the high-interest rates. This is the absolute worst of the worst when it comes to bad debt. Avoid these at all costs.
Clothes/Luxury Items/Vacations/Etc.
This category is basically just unnecessary spending in general. If you’re going into debt to purchase these items it’s never a good idea.
Now, the other idea about this that nobody tends to consider is the fact that if you’re already in debt, if you should be buying these things instead of paying off debt, but that’s a whole other article.
Either way, going into debt for luxury items or things you don’t need isn’t a good idea. Remember, if you’re not paying cash you don’t actually own these items. As for vacations? Remember, money you spend now that you don’t have is money you have to earn later on that you’re paying interest on.
Neutral Debt
Is there a type of debt that can’t really be placed into either category? I think medical debt has to fall under this category for a few different reasons.
Medical debt isn’t going to have any positive impact on our net worth, we can’t use this debt to make money, it’s not in any way bettering our future, but it’s a debt we tend to get because of necessity. Yes I’m sure you could make the argument that focusing more on your health could lessen your medical debt, but for the most part, this is something we don’t have a choice in the matter.
In other words, we don’t want to take out medical debt, but if you have to go to the emergency room or if you have a child then this is an expense you don’t have a choice of, at least within reason.
While this debt isn’t something you want any of, once you have it, it’s not as bad as other debt for 2 main reasons:
- It doesn’t accrue interest.
- They tend to let you pay whatever you can.
For these reasons alone I would consider it “good debt”, at least compared to something you’re paying interest on every month.
While you should make your minimum obligation every month it doesn’t make much sense to pay off all of your medical debt or pay more than required if you still have other debt you’re paying interest on.
Good Debt vs Bad Debt-The Main Takeaway
The bottom line is when taking out debt what primarily needs to be considered is how it affects your net worth. If you’re taking out debt that will depreciate in value or doesn’t add back the same or more value then this is what would be considered “bad debt”.
Granted, sometimes you may think it’s still worth it. But, there is a reason that most people are living their lives paycheck to paycheck, and taking on bad debt is one of the leading factors.
What about you? Do you avoid taking out bad debt? Is this something you’ve fallen victim to in the past? Is there anything else you would include here? Let me know in the comments below!