What Is The Difference Between Good Debt and Bad Debt

Most people assume that any type of debt is bad and that the ultimate goal should be to have no debt at all. However, not all debt is bad. As a matter of fact, there are many types of debt that are excellent for your credit and financial well-being. Certain debts empower you to be able to do things you would typically be unable to; for example, attend college, get a new businesses off the ground and/or build a new home. On the contrary, debts that are considered ‘bad debt’ can have serious negative implications on your credit.  Below are a few of the more common types of discretionary and fixed debts andwhat their impact on your credit are. A fixed debt or expense is a cost that does not change for you from month-to-month (mortgages, car loans, child support) while discretionary debts are expenses that change every months and are going to require you to prioritize your spending (credit card bills).

Auto Loans

An auto loan is considered a good debt since you are obtaining property that you will own from the debt. Even a better debt if having a nice car is required for furthering your career. For example, being a real estate agent will necessitate having a nice car. You don’t want to transport potential clients or show up to a sellers house in a junk mobile. However, an auto loan can be a bad debt if you buy a vehicle that you are not going to be able to afford the payments on.

Lending Money to a Friend or Family Member

Providing a loan to someone is a very bad debt unless you have a detailed agreement that outlines a specific payment schedule including interest and what happens if payments are not made (maybe you collect some type of property in the event of default). As a general rule of thumb, unless there is something for you to gain from the experience, do not lend to friends or family. It is a risky practice that usually equates to the relationship being soured. It is likely that the borrowing party is leaning on you for a loan because they have poor credit and think they can not get approved for unsecured personal loans from a bank. However, there are several online sources that specialize in providing bad credit personal loans.

Student Loans

A student loan is an excellent debt if the financing helps you complete your college education with a degree. However, a student loan can also be a bad debt if you end up dropping out of school prior to graduating.

Business Loans

Utilizing a business loan in a venture that is going to earn you money is a good debt. Obviously, a business loan that is going to equate in losses and/or you cannot afford to make payments on is a bad debt. Business loans are tricky because you will only know if you are going to earn or lose money months or years after you have already committed to the loan. Therefore, it is important that you do extensive research and planning regarding your potential new business prior to making long-term plans with a loan.

Credit Cards

When looking to pay for situations that can not be paid for all in one shot, like unexpected costs (car repairs, doctor bills), for buying large ticket items (television, computer) or for paying for a wedding or vacation a credit card is a great source of funding. Credit cards are a good debt only if you are going to be able to make your monthly payments timely; ideally in full within two or three months. If you can are unable to do either, then credit cards are a bad debt. Credit cards have limits so paying for a larger wedding may be unrealistic. If you need more funding than a credit card has to offer, consider applying for wedding loans.

Mortgages

Similar to car loans, mortgage are a good debt since you are creating equity. But if you can not afford your mortgage payments, then it is a bad debt.