Good Debt vs Bad Debt

Posted on 2014-04-01

Living in debt seems to be the norm these days – how else would we be able to afford our homes, cars and everything else we need in life. Being able to borrow money and buy things on credit has made it easier for us, we no longer have to save up for years until we can make a more significant investment. So we can say that this kind of debt is good – we can benefit from a lot of things before we have paid for them in full. But there is also bad debt. Let’s take a closer look at the two and compare the good debt vs bad debt.

Good Debt

Good debt is anything that will make you money in the future and may increase your net worth. You have heard the saying, “It takes money to make money”. This is absolutely true. Most successful businesses have started out with a loan or some kind of outside financing. Here are some form of debts that can be considered good:

  • Loans for education. Without education it is hard to find a good job, make good money and build a good life. If you invest in college education, it is likely that you can pay back your student loans in just a couple of years. Also, as you are likely to score a high paying job, your return of investment will be huge. You can’t also forget that student loans usually have better terms than most other type of credit.
  • Business investments. With a good business plan that is going to bring in lots of profits you will not only provide yourself and perhaps other people with employment, you will also not have too much trouble paying back the initial loan. The only trick is to have a realistic business plan that is foolproof.
  • Real Estate. Whether you are buying a home for yourself or invest in real estate for profit, this is another form of good debt.
  • Any other investments. As long as you will make money with the money you borrow, it is all good. Just be extra careful and leave deals with higher risks for the time when you can invest out of your own pocket.
Bad Debt

There is one simple rule that you can use to determine whether the debt is good or bad. If whatever you invest in is not going to go up in value or help you earn income, it shouldn’t be bought on credit. Also, bad debts are those that are hard for you to pay back, have unrealistic payment plans and interest rates that are not reasonable.

Any luxury that you don’t necessarily need should be only bought if you have the funds in the bank. That means expensive cars, holidays, clothes, entertainment, etc.

While it may be useful to have a credit card for emergencies, it’s not wise to max it out just because you can’t resist the newest iPhone model or want to stay at the best 5 star luxury resort instead of a 3 star budget hotel on your next holiday.

Bottom Line

When comparing good debt vs bad debt, the first will bring in money, either directly (investments) or indirectly (student loans) while the other will only cause you more financial strain.

If you are not absolutely sure you can pay back the money you are about to borrow, don’t do it. Keep your debts to minimum and take your time to consider all the pros and cons before taking out another loan – no matter if it’s good or bad.