Good Debt vs. Bad Debt

When you’re in debt over your head all debt feels like bad debt, but the truth is that some debts are worse than others. Think you can tell the good from the bad? Read on to find out.

Good Debt

Good debt—it sounds like an oxymoron doesn’t it? And yet, good debt does exist. This is the type of debt that offers the consumer benefits to offset the financial burden of the debt. These benefits include:

  • Tax advantages- Debts like mortgage loans and, in some cases, student loans qualify as good debts because they offer tax advantages that remove some of the expense associated with the loan. With a mortgage loan you can deduct the points you paid to close the loan and a portion of the interest that you pay each year. Then, with some student loans you can take a deduction for the interest that you pay.

  • Low interest- Student loans are often referred to as good debt because they carry a relatively low interest rate. For the purpose of separating good debt from bad, think of interest rates below 10% as being favorable to consumers, and worth the risk and financial burden. This interest rate threshold would place most mortgage loans in the good debt category.

  • The ability to obtain appreciating property- To justify any debt, the property secured by the loan must be something that will go up in value. Since homes have a tendency towards appreciation, a mortgage would again be an example of a good debt.

Bad Debt

If you struggle to meet your monthly minimums, and calculate your debt payoff date to be some time in the next millennium—you’ve come face-to-face with bad debt. To avoid bad debts in the future, look for the following red flags:

  • High interest- Any time you rely on a bank or another party to loan you money for a purchase, you should expect to pay interest. However, that rate needs to be reasonable. Loans with rates above 10% are seldom worth assuming, and should be considered bad debt. Since credit cards rarely fall above this rate, they are among the list of bad debts. Payday loans and high-risk mortgages also make the list of bad debts to avoid.

  • Prepayment penalties- Any loan that adds penalties for early repayment, is a bad debt. An early payoff can save you a great deal of interest, and you should be able to take advantage of that savings if you want to. Don’t let someone else tell you when the “right” time is to pay off a loan.

  • Depreciating property- Cars, clothing, gas, food, furniture and vacations are just a handful of examples of depreciating debt—that is debt attached to items that decrease in value. It doesn’t make sense to spend five years paying for a meal that you’ve already consumed or to tie yourself to a hefty car loan that now exceeds the value of the car.

Eliminating Debts: Good & Bad

To maximize the benefits of your debt repayment efforts, start with your bad debts and then work your way down to the good debts. This will save you the most money and reduce your debt burden the fastest.

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