Good Debt Vs Bad Debt is worth knowing before you think of borrowing money. In as much as some things are worth going into debt for, others can leave you in big financial trouble. We will be looking at the difference between Good Debt Vs Bad Debt, so you have a clearer perspective and know what to do.
Good debt can be described as a debt that you are able to repay responsibly depending on the loan agreement. This is because of favorable payment history and showing that you can responsibly handle a mix of the two reflected in credit scores. Also, “good debt” can be a loan that is used in financing something that will offer a good return on the investment.
Examples of Good Debt
A mortgage can be termed a good debt because it will aid you in purchasing a home to live in. Once you are able to pay off that mortgage. That home will become a big financial asset and can grow in value over time. And the monthly mortgage payments could be cheaper than rent.
If you take out a student loan to pay for university, it will help you become a graduate. This is a good investment as university graduates typically get paid more than non-graduates and more importantly because the interest rate is relatively low and you only have to repay the loan once you’re earning more than a certain amount.
Purchasing a car you can afford
Getting a car to enable you to get to work and earn a living can also be classed as a good loan. Note, however, it is important that you are able to afford the loan repayment costs as well as the running cost of the car out of your income.
Investing in your Own Business
With a loan, you can develop your own business. This can also turn out to be good debt, as long as you have a good and realistic business plan. Once your business is able to pull through, it can end up being worth far more than the loan you originally took out.
Bad debt is a debt that you are unable to repay. Also, it could be a debt that is used in financing something that does not offer a return for the investment. You can also consider a debt to be bad when it negatively impacts credit scores. Often this happens when you carry a lot of debt or when you are using much of the credit available to you (high debt to credit ratio).
Examples of Bad Debt
The following can be termed as “bad debt” which you should really consider before getting into.
Credit cards with a high-interest rate are a typical example of bad debt. If you cannot pay your credit cards in full every month, interest payments can extend the debt.
High-interest loans could include payday loans or unsecured personal loans. These debts can be considered bad debt, as the high-interest payments can be difficult for the borrower to repay. This often puts borrowers in a worse financial situation.
How to Avoid Bad Debt
Before you consider borrowing, you should consider some certain things:
- Your ability to cope with the interest rates rise in the future.
- Understand the risks and what could happen if things go wrong.
- Shop around to get the best deal.
- Borrow money with the cheapest rates as possible.
- Your ability to afford the monthly repayments.
- Understand all the terms and conditions associated with borrowing money. Read through all the fine prints before you sign on the dotted lines.
- How will borrowing money improve your finances in the long run?
- Understand the risks that could happen if things go wrong.
Good Debt Vs Bad Debt Decide
After establishing that the money you want to borrow is good debt, you have to work out exactly how much you are to borrow as well as how you will repay the debt.
You have to be careful while borrowing. This is because borrowing more than you can repay without a concrete plan for repayment can turn a good debt into bad debt.