The Difference between Good and Bad Debt
You may have heard of the terms good and bad debt. Many people will label debt as being good or bad depending on what it relates to and what it helps you to accomplish in your life While this article will discuss the differences between both good and bad debt it is important to understand that no one article can dictate the differences between good and bad debt for all people in all different circumstances. Instead, much of the determination will fall on the individual who is borrowing to determine how useful the debt is to them.
Good debt is typically considered to be debt that helps you to build or develop something that is useful or beneficial to your life in some way. Examples are funding your education with a student loan, purchasing a home through a mortgage loan, or financing a car purchase that allows you to travel to and from work to earn income. The key determinant for good debt is that it helps to build something constructive for a person whether that be a college degree, ownership of a major asset like a home or car, or the acquisition of an investment asset that can provide a future stream of income. Although, loans for people with bad credit can be used to pay emergency expenses like credit card due payments, it is not considered as a good debt.
Remember that this is a general rule that many people follow as opposed to a universal truth. While a student loan can be considered to be good debt by many, if you acquire a degree that does not have much value in terms of helping you obtain a good job then the debt may be bad in that context. Further, some colleges are very expensive and the amount that you rack up in debt on your student loans can be more than you will ever be able to repay. In this context, your student debt can be bad for you financially. The same is true of your home or car related debt. These assets depreciate over time and can be a real financial burden for an individual as time goes on without the asset backing h loan. Further, if the size of the loan makes it very difficult to meet other financial obligations it may be bad for you particularly as a home and car are not liquid assets that you can quickly dispose of an there are often significant disposal costs associated with these assets.
Bad debts are commonly considered to be those that are associated with those things that are quickly consumed and do not have lasting value for your needs. An example would be entering into debt to purchase a luxury meal. While everybody needs to eat to survive, spending on a fancy meal and borrowing money to do so can be a bad financial decision for many people. The same can be true of rapidly depreciating assets like a car. While many people need a car to go to work and to earn money borrowing money on a car that is also and beyond your needs may be considered to be bad debt as the car will depreciate in value quickly and the financial burden will remain.
Significant consideration should be made to determine whether a loan is bad or good that goes beyond a basic analysis. Much of this determination should identify the use of the loan proceeds, the cost of the loan in terms of interest and other financial burdens, and the amount of time that is needed to repay the loan. However the assessment will ultimately need to be one that considers both quantitative and qualitative factors that are important for your needs.