There is certainly a case to be made that having no debt is preferable to having bad debt. However, borrowing money and incurring debt is the only way for many people to afford major purchases such as a home. While those types of loans are usually justifiable and provide value to the person taking on the debt, there is another end of the spectrum where debt is taken on carelessly. While it is simple to distinguish between these two extremes, some other IVA debt management is more difficult to assess.
IMPORTANT TAKEAWAYS
Value debt has the potential to significantly increase your net worth or improve your life.
Borrowing money to purchase rapidly depreciating assets or for the sole purpose of consumption is considered bad debt.
Whether a debt is good or bad can sometimes be determined by an individual’s financial situation, including how much they can afford to lose.
What Exactly Is Good Debt?
The old adage “it takes money to make money” is often used to illustrate good debt. If the debt you incur helps you generate income and increase your net worth, this can be considered a positive. Debt that improves your and your family’s lives in other significant ways is also acceptable. Among the things that are frequently worth incurring debt for are:
Education.
In general, the higher an individual’s educational attainment, the greater their earning potential. Education also has a positive relationship with the ability to find work. Better educated workers are more likely to be employed in well-paying jobs and are more likely to find new ones if the need arises. A college or technical degree can frequently pay for itself within a few years of entering the workforce. However, not all degrees are created equal, so it is important to consider both the short- and long-term prospects for any field of study that interests you.
It’s your own company.
Borrowing money to start your own business can also be considered good debt. Being your own boss can be financially as well as psychologically rewarding. It can also be very difficult work. Starting your own business, like paying for education, entails risks. Many businesses fail, but your chances of success increase if you choose a field in which you are interested and knowledgeable.
Your house or other property.
There are numerous ways to profit from real estate. On the residential front, the most basic often entails taking out a mortgage to buy a home, living in the home for a few decades, and then selling the home for a profit. Meanwhile, you have the freedom of owning your own home, as well as a variety of potential tax breaks that renters do not have. Residential real estate can also be used to generate income by renting it out, and commercial real estate can be a source of cash flow and eventual capital gain if done correctly.
- Also, read this better understanding of Steps to Debt-Freedom in Less Than a Year.
What Exactly Is Bad Debt?
If you borrow to buy a depreciating asset, it is generally considered bad debt. In other words, if it will not increase in value or generate income, you should not go into debt to purchase it. As an example:
Cars.
While it may be impossible for you to live without a car, borrowing money to buy one is not a good financial decision. When you leave the car lot, the vehicle is already worth less than it was when you bought it. If you need to borrow money to buy a car, look for a loan with a low or no interest rate. You’ll still be investing a significant amount of money in a declining asset, but you won’t be paying interest on it.
Clothes and other consumables.
It is commonly stated that clothing is worth less than half of what consumers pay for it. If you look around a thrift shop, you’ll notice that “half” is being generous. Of course, you need clothes—as well as food, furniture, and a variety of other necessities—but borrowing to buy them with a high-interest credit card isn’t a wise use of debt. If you use a credit card for convenience, make sure you can pay off your entire balance. At the end of the month to avoid interest charges. Alternatively, try to pay in cash.