Debt can be helpful, but it’s important to know the difference between good and bad debt. Good debt is manageable. It can help you build credit. Bad debt can get out of control quickly and cause financial problems. It is important to know the difference between various types of debt when trying to get your finances in order. So what exactly makes good debt good, and bad debt bad? Let’s take a closer look below.
What’s the difference?
Generally, there are two types of debt: good and bad. How do you know what’s good and bad?
Good debt is usually something that can help you increase your earning potential or build wealth. For example, a student loan can often be a good investment. This is because it allows you to get valuable skills that can improve your career prospects and help you earn more money.
On the other hand, bad debt is associated with buying things you don’t need and won’t be useful for a long time. Fr example, some people might try to buy designer clothes on credit or spend too much money trying to keep up with others.
What’s considered bad debt?
Credit card debt
Bad debt can take many forms, but credit card debt is one of the most common types.
Credit cards can be a useful tool for making purchases, but they also tend to have high-interest rates. Having access to money from a credit card can tempt people into making unwise spending decisions. They spend overlooking the fact they have to pay the money back or just how much they’re spending. If someone doesn’t pay their credit card on time, they might have to pay late fees or a higher interest rate. Their credit score may be negatively affected too.
These characteristics of credit card debt make it a less favourable debt choice.
Payday loans
Payday loans can have serious consequences for borrowers. These high-interest loans are typically taken out by people who have low income or poor credit history. They often cause financial distress as borrowers struggle to keep up with their monthly payments. Payday loans charge very high fees and interest rates. This can trap people in a cycle of debt.
Overall, payday loans are a bad way to borrow money.
Auto loans
Auto loans are considered unfavourable debt because cars depreciate very quickly. By the time the loan is paid off the car is worth less than what you paid for it, resulting in negative equity. Plus, cars take up space and cost money to maintain over time.
Despite these downsides, there aren’t considered as bad as other forms of debt. For example, owning a car can make it easier to commute to work or transport children around town. However, that doesn’t mean you need to purchase the most expensive car available.
Also, for those who do not have good credit, an auto loan, if managed responsibly, can be a way to rebuild it over time.
Finally, car loans tend to have a lower interest rate than other types of loans. This is because they are considered secured loans. Secured loans are loans backed up by collateral. Having collateral as backup means the lender has a way of recouping a portion of their loan should a borrower default. this being the case, they are willing to lend out money at a lower rate.
Which way to look at an auto loan depends on each person’s financial situation and goals.
What’s good debt?
Mortgage
A mortgage is often a good type of debt because it is an investment in an asset that appreciates.
Many real estate investments require borrowing money to make more money. This is called “good” debt because it can help you build wealth over time.
Borrowing money to finance real estate can be a smart choice for anyone looking to invest wisely. This can be a great way to take advantage of the opportunities available in today’s economy.
Home Equity Line Of Credit (HELOC)
A HELOC is a way for you to borrow money against the value of your home. This type of credit typically has a low-interest rate and flexible repayment timelines. This type of debt is usually manageable and can help you achieve your financial goals.
For example, if you need to make a large home renovation or consolidate some high-interest loans, a HELOC can provide the funds you need. This will let you keep your monthly payments manageable.
Good debt from a HELOC can help your credit score get better over time. Using this type of debt can be a good way to achieve financial success.
Small business loan
Small business loans are often seen as a good form of debt, as they can help to support the growth and success of new businesses.
They often have lower interest charges than other types of loans. Which makes them more affordable for small business owners.
However, whether a small business loan is the right choice will depend on the financial situation of the business and its owner. If you can afford to make monthly payments without risking your business, a small business loan may be beneficial for your company.
Student loan
Student loans can help people pay for their education. This can give them a chance to learn more and get a better job in the future.
Student loans offer lower interest rates and more flexible repayment terms than other types of debt.
Although having a lot of debt can be a problem, student loans can actually help you achieve your long-term goals.
Good vs bad debt: final thoughts
While it may be impossible to avoid all debt, it is important to understand the difference between good and bad debt. Good debt can help you build your credit score and improve your financial situation in the long run. Bad debt can damage your credit score and put you in a worse financial position. If you are thinking about getting a loan, make sure you do your research so you can make a good decision.
If you need help getting out of debt, contact one of our qualified credit counsellors today.
