You have probably heard, more than once by now, that not all debt is created equal. Some types of debt are beneficial, while others, not so much. As consumers, understanding the difference can have a profound effect on your credit score and how lenders view your spending, buying, and borrowing habits. These are the things you need to know about the types of debt worth having.
Many individuals believe all debt is bad. It represents money you owe. For these people, the amount of debt they owe places them solidly outside of their comfort zone. However, some debt is viewed more favorably by lenders as signs of responsible borrowing than others.
- Home loans. A home loan or mortgage is considered good debt. That is because homes largely appreciate over time rather than the opposite, which occurs with almost any other asset. The understanding is simple. Homes are investments that grow in value over time – unless homeowners allow them to fall to neglect.
- Home improvement loans. Some home improvement loans are also viewed as good debts as they tend to add value to the home.
- Educational loans. Another type of debt that lenders consider 'good' are educational loans. Student loans are investments in education that have the opportunity to help you increase your income and earnings based on your newly acquired knowledge or skills. Again, these types of debt will yield an increased return for borrowers.
- Small business loans. Investing in a small business is also considered good debt by lenders. Small business loans work to build equity, wealth, and solidify communities. It’s a win for the borrower and the local community where the borrower operates.
The underlying theme for all of these is that good debt is debt that has the potential to help you add to your net worth, either through the appreciation of assets or generation of income. If your goal for borrowing money is for a different purpose or goes in a different direction, it will likely fall in the 'bad debt' category.
Bad debts involve assets that depreciate over time. These debts are not considered investments so much as they are considered consumption. The idea being that if items do not increase in value or generate wealth, people should not go into debt to purchase those items. Prime examples of bad debt include:
- Vehicles. The average new car depreciates the moment you drive it off the dealership lot. Moreover, the depreciation rate is anything but minimal. Paying interest on purchases that fall in value at such alarming rates is often considered to be throwing good money after bad.
- Credit Cards. These are some of the worst offenders. Not only are these debts often used for absolute consumables (dinners out, fuel for vehicles, and entertainment), they have shockingly high-interest rates making these items cost considerably more over time.
- Payday loans. Often prime examples of someone living beyond their means, payday loans represent a huge money drain for many people in the general population. You are essentially leveraging your future income for cash in hand today.
These debts do not lift families out of debt and may doom them to struggle with debt for longer than necessary.
While we do live in a consumer-driven society and debt is an often necessary fact of life, the types of debt you have can profoundly impact your quality of life and ability to have the things you desire most in the end.
The best words of wisdom to offer on the debt front involve keeping your debt focused on things that can help you increase your net worth and reducing debt that does precisely the opposite, whenever possible.