We all have some sort of debt that ranges from credit cards and auto financing to home mortgages and student loans. While some debt is inevitable, it's important to understand that not all debt is created equal. This blog will help you recognize the difference between good and bad debt.
Good Debt – Any type of low-interest debt that can assist in building your net worth is considered good debt.
Examples include:
Bad Debt – Any type of high-interest debt that is costing you money while not adding any net worth is considered bad debt.
Examples include:
It's also important to know that good debt vs. bad debt isn’t always black and white. Just about any debt incurred can be considered good or bad, depending on how you look at it. Often, the debt incurred is really more about your spending and repayment habits, which can make all the difference.
Credit cards can be useful in some situations. Depending on how they're managed determines whether the debt is actually helpful or harmful. Factors such as spending habits, interest rates, balances, and repayment practices are the deciding factors in determining whether credit card debt is good or bad. Carrying a balance each month, missing payments, or making late payments can result in negative financial consequences that lead to burdensome debt.
However, responsible credit card use as a result of making on time payments, paying off balances each month, and keeping a low credit utilization ratio, can positively support your financial goals.
Buy now, pay later (BNPL) services are short-term loans and can be helpful when making a planned or necessary purchase that has a repayment plan in place. As with any loan, it's wise to have a strong understanding of it's conditions, terms, and repayment agreement. Failure to do so can result in added fees, service charges, or other hidden costs. Much like credit cards, irresponsible use of BNPL services can have a negative impact on your finances.
These types of loans are somewhere in the middle debt – not necessarily good or bad. Depending on various factors such as down payment, interest rate, loan term, whether it's a primary or secondary vehicle and more, an auto or recreation loan could be considered good or bad debt. If the monthly payment makes covering other expenses difficult to keep up with, this may be an indicator that the debt is causing more harm to your financial picture.
Understanding the difference between good and bad debt and debt that falls into gray areas can help you make informed borrowing decisions that protect your financial health. Be sure to pay close attention to the true cost of borrowing, don't borrow more than you can afford, and choose a repayment strategy that fits comfortably in your budget without disrupting other bills.
The real key to financial success is to avoid and reduce bad debt as much as possible. Here are some smart money tips that can help you avoid and eliminate bad debt.
Avoid Taking on Unnecessary Debt – Budgeting is crucial to ensuring you can afford new purchases without taking on new debt. If borrowing is in your plan, be sure to evaluate any major purchases and compare your loan options to ensure it makes good money sense.
Create a Debt Repayment Strategy – While having some debt is inevitable, it's important to create a debt repayment strategy that works with your budget. Prioritize balances and make an effort to consistently reduce debt to keep your finances in check.
Live Within or Below Your Means – Living within your means (as best as you can) is important for financial success. Bad debts weaken your financial future by lowering your net worth and reducing your income.
As previously mentioned, not all debt is created equal. Some debts are considered good, some bad, and others fall somewhere in the middle. The key is finding a healthy balance that fits your needs so you can live and breathe easier. If you'd like to explore a different path for managing debt, contact us or stop by a local branch today.
Or, if you'd like to do some research on your own, check out a few of our favorite debt consolidation resources below:
As a member of Peach State, you also have FREE access to financial education and resources on variety of topics – including debt consolidation – from the industry experts at Balance.