We all know that being in debt isn’t ideal. But sometimes living without it just isn’t realistic. Life happens and you may need to borrow money to cover costs.
Fortunately, not all debt is created equal, and there’s a place for good debt in your personal financial plan. But first, it’s important to understand the difference between good debt and bad debt.
Debt that helps you achieve your goals and get ahead in life is typically considered to be good debt. This type of debt might help you generate income, which could increase your net worth. With very few exceptions, good debt gets a thumbs-up.
- Student loans: Low-interest loans that help you pay for college or technical school are considered good debt because, generally speaking, education leads to employment and greater earning power.
- Mortgages: Homeownership is part of the American dream, and for good reason. Not only will you have a roof over your head, but you might also be able to sell your home for a profit down the road.
- Small-business loans: Borrowing money to start and run a business provides an opportunity to grow a profitable company and live on what you earn. And hard work could lead to even greater earnings.
If you borrow money to purchase an item that depreciates (one that won’t increase in value or generate income), then you’re taking on bad debt. These loans typically come with high or variable interest rates and are most often used for nonessential items that lose value.
- Credit cards: Credit cards typically have a high interest rate, making it difficult to stay ahead unless you can pay the entire balance each month. Using your credit card for discretionary purchases, such as clothes or entertainment, is generally considered a slippery slope that could lead to a mountain of debt.
Other types of debt
Not all debt fits neatly into the good or bad categories. Car loans may be necessary if you need transportation to work. But purchasing a vehicle that’s beyond your means could be a strain on your budget. You may have heard that an automobile depreciates the minute you drive it off the lot, and that’s true. It does nothing to increase your net worth or improve your financial situation.
If you must borrow money to buy a car, shop around for one that fits your budget. Depending on your situation, that could mean buying a used vehicle with a low-interest loan that you pay off quickly – or it might make sense to buy a new car if you intend to hold on to it for many years.
Low-interest personal loans also fall into the gray area, especially when they’re designed to help you save money by consolidating or refinancing high-interest credit card debt. In this case, a larger low-interest loan is used to pay off many smaller high-interest loans, making it easier to manage your debt.
The risks and the rewards
For many, debt is an unavoidable part of life. But even good debt isn’t without risk. That’s why it’s important to do your homework and come up with a plan for paying off the loan. A budget app and debt plan can help you stay the course.
It’s not easy to postpone a purchase that you really want – or even need – today. But waiting could pay off in the long run, and it’s better to borrow money for things that invest in your future or increase your net worth. With that in mind, don’t overlook the fact that having a personal budget can help you achieve your long-term financial goals.