Contrary to popular belief that there’s no such thing as “good debt,” most financial experts agree that certain types of debt can actually work out in your favor, so long as you stick to the terms of the payment plan.
Being that the COVID-19 pandemic is causing financial strain for American households, now is a great time to review the types of debt – and what’s considered good debt and bad debt. Knowing this information can help you rebound faster should you have to tap alternative sources to keep your household or your business solvent as we make our way through and out of the pandemic.
Here’s a closer look:
Good Debt
The two best examples of good debt are student loan debt and mortgages. A good rule of thumb to follow with what’s considered good debt is if it can increase your net worth or has any sort of future value, which mortgages and student loans certainly do.
Let’s start with mortgage debt, which from a historical perspective is often considered the safest, best form of debt. This is largely because it’s considered an investment, and as you make your monthly payments, you’re building equity. Mortgages are also typically a safe investment, just as long as you’re not on an adjustable rate loan and aren’t borrowing more than what you can afford. Mortgages can also help you build positive credit history, which can provide a major boost to your credit score over time.
While it’s common to bemoan student loan debt, most experts suggest trying to think of this type of debt as an investment in your future. After all, you’re taking out student loans so you can go to college and earn a degree. Additionally, you’re likely taking out student loans when you’re in your late teenage years, which can help with building credit. Credit history is one of the several leading factors that help account for your credit score.
Small business loans and home equity loans are other examples of good debt.
Bad Debt
Bad debt tends to be revolving debt or high-interest loans. Essentially, think of bad debt as anything that you can’t pay cash for, but probably should be able to pay cash for in order to acquire it. We’re not saying that having a credit card and using it is a bad thing, but any purchase you make on a credit card should ideally be paid off monthly. If it’s not, then this debt can build up, carry over from month to month and cost much more to pay off due to high interest rates in the long term.
High interest loans, or payday loans, is also bad debt that tends to trap consumers into a revolving door of having to make payments at high interest rates in order to pay it back.
Automobile loans are also considered bad debt, however they’re often necessary debt to take on. They’re considered bad debt because vehicles only last for so long and depreciate quickly.
