Contrary to popular belief, not all debts are equal. There are good debts and bad debts, with quite big differences between the two. Many people think that having no debt is ideal, but in a lot of circumstances, having some debt can be considered good for your credit score and financial stability. This can help with your future financial decisions, such as buying a house or furthering your education. With that in mind, let’s take a look at some of the differences between good and bad debt, as well as some examples of each.
What Is Good Debt?
If the debts you hold allow you to generate additional income or build upon your net worth, then this can be considered good debt. Holding some debt in your name can be beneficial to your overall financial health, such as holding a mortgage or going into further education. Good debt is typically has a clear purpose and is generally associated with getting a return on investment.
Further Education
Generally speaking, the higher your level of education, then the greater your potential to earn a higher wage. It also has a more positive correlation with being able to better find employment. Taking out a student loan provides you with what lenders see as “bankable knowledge” and they will likely see a much earlier repayment of the loan should you secure a good job or become a high earner.
Mortgages
A mortgage which lets you finance a property is a type of good debt which can bring long-lasting benefits. For example, a typical 30-year fixed rate mortgage which has affordable payments can provide a long-term home for you and your family as you grow older and, should you take care of and maintain the property, then there is a good chance that you’ll be able to sell it and make more than what you originally paid.
Car Loans
Over time, cars end up losing a lot of their original value. Unless it is a classic car, then, generally speaking, cars are not seen as a lifetime investment. However, taking out a car loan can be seen as good debt should it give you a reliable method of transportation, under certain conditions and repayment terms. As it is a regular repayment, often being made every month, if you stick to the repayment plan then this can help build your credit score.
What Is Bad Debt?
Bad debt is typically considered to be debt which isn’t healthy for your overall finances, or which comes with high interest rates. If you are using, for example, a revolving line of credit, such as a credit card, and reaching the maximum amount, then this will have a negative impact on your credit score. Carrying too much bad debt, or having debt in an asset which has a depreciating value, may affect your potential to borrow in the future.
Irresponsible Credit Card Debt
Of course, using credit cards to cover everyday payments is fine, if they come with benefits such as travel miles or cashback rewards and you ensure to pay back the balance each month. But, carrying large amounts of credit card debt over time without making much of a dent in the repayments can be seen as bad debt. If you’re only able to make the minimum repayment value on an ever-growing credit card balance, then this could impact your credit score.
Payday Loans
Payday loans are short term loans for small monetary values. They used to be highly available on the high street, but are now more readily available online. They can be easy for people to apply and get, but they carry with them very high-interest rates and can negatively impact your credit score. There are many other alternatives if you are struggling financially, such as DRO, so always be sure to consider other options before taking out a payday loan.
Remember, if you are struggling with bad debt or debt in general, it’s always best to speak with an independent debt financial advisor who can guide you on the next steps to take towards being debt-free.