Most people have a negative association with debt. However, not all debt is created equal. Some debt can be considered ‘good’ while some debt is undoubtedly ‘bad’ for you and your financial wellbeing.
In this article, we will discuss the difference between ‘good debt’ and ‘bad debt’ to clarify what debt you should be taking on and what debt you should be avoiding.
Credit card debt is bad debt.
Bad debt
In simple terms, bad debt is debt that reduces your spending capacity and limits your ability to invest. Examples of bad debt would be credit card debt, consumer loans, and car loans. Basically, any debt you incur because you are purchasing something you actually can’t afford is bad as it reduces your ability to invest and grow your wealth.
Purchasing an expensive new flat screen HD TV for your living room using your credit card, for example, is a horrible idea. Not only will you have to pay off the full price of the TV over several months, which will reduce your spending and investing capability, but you will also accrue interest on your outstanding credit card balance. This, in turn, will increase the amount you actually end up paying for the new television.
Another example of bad debt would be to purchase a brand new car using a car loan. A new car loses a substantial amount of its value once you drive it out of the car dealership, but if you have purchased it using a car loan, you still end up paying the full price for something that immediately drops in value.
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Good debt
Good debt is debt you take on when making smart investments, such as investing in your education, growing your business or buying investment properties.
While student loans can feel quite financially restraining at times, provided you choose a degree that will lead to a well-paying career, they would fall under the category good debt. Your education will help you to have a successful career and, in many cases, give you a solid foundation to start your own entrepreneurial venture.
Another example of good debt would be purchasing properties as investments. Taking out a mortgage on an investment property, which you rent out to tenants, will bring you monthly rental income and an appreciation in property value over a ten-year period or more. Once the rental income has paid off the mortgage in full, all further rental income is pure profit and the appreciation in property value will add to your net worth.
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