When you think of consumer debt, it’s important to understand that there are distinct differences between certain types of debt.
Here’s a breakdown that explains both “good” and “bad” debt – and why some experts may classify them in these ways.
MORTGAGE DEBT = GOOD DEBT
Mortgage debt typically falls under the “good” debt category because it helps you maintain a strong credit history and your investment is tax-deductible. Your house is also an asset that can appreciate over time. And when it does, real estate ownership helps you build wealth.
Of course, home prices don’t always rise. So even though mortgage debt is usually considered “good debt,” avoid signing for a mortgage that you can’t afford. That would make a “good” real estate loan a decidedly “bad” deal.
CREDIT CARD DEBT = BAD DEBT
Credit card debt often falls under the “bad” debt category because you never earn a return on your purchases. In fact, making only minimum payments can lead to more debt (i.e. interest) over the long-term.
Credit cards typically have higher interest rates than other loans, such as mortgages, and carrying a lot of credit card debt lowers your credit score. Finally, credit card debt is not tax-deductible.
For all of these reasons, it’s best to use credit cards wisely – charging only what you can afford to pay off in full each month. That’s the ideal way to keep credit card debt from becoming excessive, “bad” debt.
STUDENT LOAN DEBT = GOOD DEBT
Student loans are considered “good debt” because they often have low interest rates, they may be tax deductible, and they’re an investment in your future earnings. Over a lifetime, the typical college grad will earn $1 million more than the average high school graduate, according to the U.S. Labor Department.
Still, from a practical standpoint, it’s unwise to borrow excessively for college – especially if you’ll be in a modest paying career.
AUTO LOAN DEBT = BAD DEBT
A car loan is usually regarded as “bad” debt mainly because the value of a new car depreciates once you drive it off the lot. Additionally, if you buy a vehicle with a very long repayment term (like 7 years), your car loan can outlast the warranty on the vehicle.
As with all conventional wisdom, however, there are times when the opposite point of view also holds merit – which is why there can be some financial benefits in buying a new car that you can’t get from a used car.
For example, new cars are far more fuel-efficient than old ones, and you can get more competitive financing and leasing options – such as 0% financing deals – with new cars rather than pre-owned vehicles.
So the main point to remember is that even though experts like to classify various forms of debt into black-and-white categories such as “good” debt and “bad” debt, the lines can sometimes be blurred.
In truth, any type of debt that is unaffordable, excessive or for which you don’t have a concrete payoff plan – even so-called “good” debt – can easily turn into “bad” debt if you’re not using smart credit and debt management strategies.
Source: startingout.tiaa-cref.org ~ Author: Lynnette Khalfani-Cox