How to differentiate good debt and bad debt

Being indebted to a person or business is never a comfortable feeling. For most people, they want to pay off that debt as quickly as possible. Today’s society, however, is full of debt every single day of the year. When you become an adult, credit-card offers, student loans and other monetary transactions are suddenly at your doorstep. Before you take on any debt, it’s a good idea to understand the differences between the monetary types. In the financial world, there’s either good or bad debt. Get to know these debt types before you sign on the dotted line.


1. Investments Build Wealth


Good debt offers you a return for your indebtedness. You might invest in a home for your family or start a business. Neither of these two situations can be accomplished with cash alone. You’ll have to take out a bank loan. Credit histories aren’t marred by this good debt because you’re growing wealth as a result of that loan. You’ll pay back the funding at some point while enjoying growing equity on the home or business.


2. Credit Cards Create Unsecured Debt


The worst debt in the eyes of the banking industry is credit-card balances. These debts don’t build wealth. In fact, they actually pull you further into debt with these charges, including:


  • Interest fees


  • Administration charges


  • Yearly membership fees


The irony of the situation is that building credit requires a credit card in most cases. Use your card wisely by only spending what you can pay off each month. Carrying a balance will only push you further into debt.


3. Student and Home Equity Loans


There might be some confusion surrounding student-loan and home-equity debt. When you take out a student loan, you’re investing in yourself. Although this is a lofty concept, you’re still benefiting from the loan by learning skills to better your future and the community. These loans are considered good types. Home-equity loans are also good debt because the funds taken out of the equity are meant to improve the property. Take out this loan, and add a roof to the house. This investment will pay off over time.


4. Considering Auto Loans


Consumers are often confused about auto loans and their importance to your credit history. Although paying off an auto loan helps your credit score, this common debt is considered to be bad. A vehicle isn’t an investment. It actually loses value from the moment that you drive it out of the dealership lot. Vehicles will never increase in value so be wary about using a car purchase as an investment ploy.


5. Being Aware of Interest Rates


Regardless of the type of debt, any loan is a bad one when the interest rates are incredibly high. Ideally, you want the lowest rate possible because it directly influences the monthly payment. Stay on top of monthly payments too. You may have a low interest rate, but it will adjust upward when you miss a payment. The adjustment is usually a severe penalty.


Learning how to manage debt isn’t a skill that’s usually taught in school. You may want to take a class on personal, money management. Being aware of income and spending habits will keep your household afloat in any economy. In the end, knowledge is power as you decide between good and bad debt.

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