Good debt vs bad debt

Updated: Feb 19, 2020

On average, three quarters of Americans die with $61,000 in debt, that’s 70% of Americans living their whole life’s without being able to pay their debts. The question is what kind of debt is it that they’re getting themselves into that’s following them for their whole life?

There is an argument that all debt is bad, and in an ideal world no one would have any kind of debt, but many people don’t have the purchasing power for big ticket items such as houses and cars so end up taking loans and other sources of funding to make these purchases. Understanding the difference between good and bad debt is an important step to gaining financial freedom. However, not all debt can be so easily categorised into good or bad, there are some special considerations that depend on your financial situation.

Everyone knows the old saying – “It takes money to make money”. If the debt you are taking on helps to make an income and increases your net worth it can usually be considered as a good debt. Here are some things that I consider being worth getting into debt for:

1) Education. It is important to invest in yourself; this should always be your main priority. In general, the more education a person has received the higher their earning potential. If a debt is incurred in getting your education such as a student loan or for other course fees it is more than likely that it will pay for itself in the long run. To get the maximum amount of value from taking out debt for studies ensure you chose your degree programmes carefully as student loans can quickly turn into bad debt.

2) Business ownership. Making money is the main purpose of owning a business while also being your own boss being a positive. How much time and effort you are willing to put into your business will correlate with how successful it is, and how much money it makes. A business is a huge investment, not only financially, but with time and energy - if you do not apply yourself to your business you could end up failing like many small businesses do, like education make sure you are pursuing something you are passionate about.

3) Real Estate. Another very common form of debt is the mortgage, it’s important not to forget that it is the bank designing these products for their profit. The idea being that the value of your property increases to cover the interest you pay but in some cases, this is not always true, the longer you own the property the more equity you hold thus the more value of the property you own. Residential properties can also be used for income by renting out the whole residents.

While good debt has the potential to increase a person’s net worth, taking out debt to purchase depreciating assets or items that do not increase in value/generate income can be classed as bad debt. Things commonly purchased with bad debt include Cars, Electronics, Clothes and Holidays.

If these kind of things are purchased through Prime loans, Credit cards, Payday loans (subprime loans) or other general high interest payment schemes it can cause a lot of troubles for the consumer. These kinds of products are generally designed to target those who are not financially educated or may be experiencing financial problems.

All debts are liabilities until they are paid off, so the idea is not to incur more liabilities over time and to reduce them if and when possible. If you’re thinking about getting into debt for a purchase – think about your end goal and how it will benefit you in the future ,do not get yourself into debt to make things appear better to others like so many people do, as this will only hinder your growth – stop comparing yourself to others. Don’t be jealous of their new car or new watch, be happy for them and continue to focus on your own financial goals because more often than not things appear better on the surface than they really are.

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