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Good and Bad Debt: When “Debt” is More Than a 4-Letter Word

Differentiate between good and bad debt

When you’re considering borrowing cash, there’s a lot to think about. When will I be able to start paying this loan off? Will my income or assets change in the future? What is my motivation for taking on this debt? What will I gain if I put off paying until later? What will I gain if I pay up early?

Needless to say, the decision to go into debt for any reason can be complex. To further complicate things, you may have heard the terms good and bad debt. Sometimes, answers to the questions start adding up to form a positive picture. This is when a particular debt can be classified as “good debt.”

If you’ve ever been in the position of owing money, you know it can be stressful. Especially if you’re not able to settle up as quickly. But what if you entered a loan knowing that while you made the minimum monthly payments, that debt would actually go to work for you, enhancing your future income? The stress dissipates, and while you know you’re ultimately responsible for paying the debt, you also know that it’s working for your benefit in the meantime.

When Cash is Not King

In short, a debt that is accrued in order to boost future ability to pay is a good debt. Examples may include school loans (assuming your degree choice is in a field where careers are abundant but qualified candidates are not), a viable business startup loan, or a property that’s likely to appreciate in value at a good clip.

Bad debt, as you may already have experienced, is that impulse buy that seemed “hot” at the time. The things we do or get that satisfy a fleeting emotion like the desire to look good or gain approval from others --- these are the purchases that should not be achieved with credit.

Believe it or not, many debts fall into a grey area. For example, a vehicle that gets you to a well-paying job is definitely an asset worth going into debt for, but not if you’re opting for the latest, most expensive ride with all the bells and whistles in order to impress your officemates. Since vehicles very rarely gain value, consider the loan an investment in your ability to earn a paycheck, not a surefire way to gain recognition.

Also, a person can easily convince himself that a bad debt is good. It’s much easier to look at someone else’s set of circumstances and determine whether the debt is wise. So when it comes to your own decisions, consult someone whose financial status you respect before signing on any dotted lines.

Remember never to accrue more debt than you can pay back comfortably, and never allow your debt to climb above 35% of your pre-tax income, since the credit bureaus do not specify between good and bad debt when calculating your score.

Whether a bank, the government or a payday loan service, one thing remains certain: Your motives and your ability to pay back comfortably are not your debtor’s concern. It is your responsibility to distinguish between good and bad debt.

Image Source: Flickr

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