While putting oneself in the red may seem intimidating, there are times in which debt is beneficial. However, it is important to discern which circumstances can justify borrowing and taking on debt. Things like a home or an education often require the assistance of loans. However, when debt is accumulated with irresponsible spending habits, it can easily be rendered “bad.” Let’s take a look at both the explicit and less-obvious examples of good and bad debt.
Good debt can be defined as borrowed money that helps one generate income with the potential to increase their net worth. This money is spent on things that have promise for the future’s financial stability and gain. Investments like education, a small business, and real estate can often fall into this category:
- Education. Generally, education is beneficial not only for one’s personal growth but for their financial gain as well. There is a direct correlation with education level, and one’s earning and employment potential. However, it is crucial to choose your field of study carefully. Consider your career path and its promise to make money. If you invest in an education that cannot pay for itself, you may find yourself in some “bad” debt.
- Real estate and homeownership. Becoming a homeowner can be a great investment. But it takes time. Plan to live in your home for several decades before selling it for profit. You might also consider the option of renting out a property to enjoy some passive income. If you choose your housing options carefully, this can be a great financial move and a wise investment.
Bad debt, in contrast, can be described as borrowed money that is spent on depreciating goods. They will not increase in value, nor will they have the promise to generate income. As a general rule, do not go into debt for such things.
- Cars. Cars are expensive. Even if you don’t have your eye on a Maserati, most new vehicles are quite pricey. Plus, upon their departure from the dealership, cars instantly lose value.
- Credit cards. You may have assumed this to be a culprit of bad debt. Their interest rates are significantly higher than those on consumer loans. And as such, even small amounts of credit card debt can devastate your financial standing. Be sure to always spend within your means and pay off your credit card bills on time.
It’s safe to say that not all debt is inherently bad. Loans can certainly be used wisely and are even necessary for several big-ticket items. However, they should serve a purpose and be used intentionally. If your debt is working for your future financial gain, you’re likely in the clear. But if you use borrowed money for temporary investments, you may need to re-evaluate your spending choices.