There are only a few people in the world who can make it through life without borrowing any money. For a majority of Americans, debt will have to incurred in order to pay for many of the large expenses in life including a college education and a home. Society has attached a negative stigma to […]
There are only a few people in the world who can make it through life without borrowing any money. For a majority of Americans, debt will have to incurred in order to pay for many of the large expenses in life including a college education and a home. Society has attached a negative stigma to the word ‘debt’ that makes many people weary of borrowing any money. While there are certainly times where debt is bad, it isn’t always the case. There is a clear distinction between good and bad debt that often becomes overshadowed by the negative ideas associated with debt overall.
Good debt refers to borrowed money that will generate further income or increase in value in the future. This type of debt should be viewed as an investment. For example, borrowing money from the bank or government in the form of student loans is a good form of debt. Not only are the terms of the loan reasonable (i.e. low interest rates), the long-term gain will be an education. This will hopefully result in a higher paying job in the future.
A mortgage used to purchase a home is another example of good debt. As long as this loan is taken out with low financial risk, the future benefits will outweigh the current debt. Governments and banks incentivize the use of mortgages by offering tax deductions and low interest rates. Instead of having to spend all of their savings on a home, mortgages allow homeowners to pay-off their home with low monthly payments. This allows homeowners to use their money for emergencies or to make other investments. Homes can also appreciate in value overtime and effectively cancel out the interest costs paid on top of the debt.
Loans taken out for vehicles can also be good forms of debt. Many homeowners need a car for their daily life. Whether driving to work or taking kids to school, there are many times when a car is required. In these scenarios, an auto loan would be viewed as good debt. Vehicles depreciate in value overtime in contrast to homes. For this reason, it is important to pay off this form of debt as quickly as possible.
Credit cards are another form of good debt. When placing a charge on a credit card, the amount doesn’t directly come out of any linked account. Instead, the associated bank will send a monthly bill of which a percentage must be paid. This good form of debt can help a person build credit over the long-term and increase their eligibility for future loans.
Bad debt refers to any form of borrowing money for objects that quickly lose value over time or do not produce income in the future. There are infinitely more forms of bad debt than good debt. In general, anything that cannot be paid back is considered bad debt. Borrowing money from the bank to buy a new sports car and defaulting on the payments is a classic example of this form of debt in real life. Bad debt will end up making purchases cost more money in the long run with all of the extra interest and penalties incurred.
Although credit card debt was mentioned before as a good form of borrowing, there are times when this debt can be bad. As a general rule of thumb, credit card payments should be made on a monthly basis. When people begin defaulting on their credit card payments, there interest rates will continue to skyrocket as the debt accumulates. This will also hurt a person’s credit score in the long run.
Other bad forms of debt often are incurred while people are already in debt. The desperation of needing money drives people to make more bad decisions. For example, cash advance or payday loans are notorious for being the worst forms of debt. With these types of loans, a borrower will write a check to a lender for an amount that he or she wants to borrow. The borrower has until the next payday to repay the loan and any additional fees incurred. Payday loans typically come with ridiculously high interest rates. Any borrower that fails to make these payments will only incur more debt and higher interest rates.
People enter a cycle of debt by continuously trying to pay off their current debt by borrowing more money. Debt should be used cautiously and deliberately. There needs to be a justified and logical reason for borrowing money. Borrowers also need to have a clear repayment plan for the future. All of these characteristics can help make certain kinds of debt more stable.
Debt isn’t an all-inclusive word. It simply refers to the practice of borrowing money in the short-term in order to make an expensive purchase. There are times when this practice is good and bad. Debt should be viewed as existing on a spectrum from good to bad debt. When used properly, debt can help people build a comfortable life. However, bad debt can lead down a road of regret and trouble. It is crucial to only incur good debt over a lifetime.