Q: I’ve been thinking about debt, and I’ve been wondering: Is all debt bad? Does good debt actually exist?
A: Despite its bad rap, not all debt is bad debt. Some debts are actually beneficial for the debtor and can be considered “good debt.” Let’s take a look at the factors defining good debt, the various types of good debt and how to keep this debt from going bad.
What is good debt?
Good debt is a term used to describe types of debt that help you build wealth or increase your net worth. Unlike bad debt, which includes long-term credit card debt and other forms of high-interest debt that don’t add value to your financial situation, good debt is an investment that can ultimately pay off and benefit you.
Types of good debt
Now that we’ve established what defines good debt, let’s explore several kinds:
A mortgage is generally considered good debt because it allows you to buy a home, which can appreciate in value over time. Each monthly payment you make on your mortgage builds equity in your home, which can be used as collateral for future loans or as a source of funding for retirement.
- Home equity loans and lines of credit
Another option for accessing the equity in your home is through a home equity loan (HEL) or line of credit (HELOC). These loans, which are secured by your home, can be used for a variety of purposes, such as home renovations or debt consolidation. In many instances, the rates of these loans make for a much lower cost than carrying it on higher interest credit cards.
Student loans are generally considered good debt because they can lead to higher-paying jobs and increased earning potential. By investing in your education, you can improve your chances of achieving financial stability and your long-term goals. In addition, some student loans only begin accruing interest following a grace period after you leave school.
An auto loan can be good debt if it enables you to purchase reliable transportation that you need to get to work or to run a business.
A business loan can fall into the category of good debt if it allows you to start or grow a business that generates income and increases your overall financial health.
Can good debt turn into bad debt?
While good debt can help you build wealth and improve your overall financial wellness, it can quickly turn into bad debt if you miss a few payments or the investment does not quite turn out as planned.
For example, if you take on too much mortgage debt or buy a car you can’t really afford, you may struggle to make the payments and risk foreclosure. Similarly, if you invest in a business that doesn’t generate income, you may struggle to repay the loan and risk bankruptcy. Finally, defaulting on a student loan can have serious consequences, like hurting your credit score and having your wages garnished.
Be sure to carefully consider the risks and rewards of taking out a loan and to have a solid plan in place for repaying the debt before applying for any loan.
How can I keep my good debt from going bad?
If you have one or more good debts that you don’t want to turn into bad debts, we can help! Follow these tips to keep your debts from going bad.
- Only borrow what you can afford. Determine how you will fit the payment into your budget before applying.
- Choose loans with favorable terms. Look for loans with low interest rates, reasonable repayment terms and no prepayment penalties.
- Make timely payments. Pay your bills on time to avoid late fees and to keep your credit score high.
- Monitor your credit score. Check your credit report regularly to ensure that your debt is being reported accurately and to identify any errors or fraud.
- Stay informed. Keep up-to-date on changes in interest rates or other factors that may affect your debt.
Good debt does exist! It can be a valuable tool for building wealth and strong creditworthiness, but it needs to be managed responsibly to keep it from going bad. Use the tips outlined here to identify your good debts and learn how to manage them well.