Excessive debts can turn good debts into bad debts. They may borrow too much money for important goals like college, a home, or a car. Too much debt, even if it’s at a low interest rate, can turn into bad debts. Carrying debts without a good plan to pay off can lead to an unsustainable lifestyle.
Low-interest debt, which you can use to increase your income or wealth, are examples of good debt. But too much debt of any kind, regardless of the opportunity it creates, can turn it into bad debt. Student loans and mortgages are marketed as good debt. However, credit card debt is considered bad.
The common belief is that it’s okay to take on debt that can either increase your wealth or increase your earning potential. Good debt allows you to manage your finances more effectively, use your assets, buy things you need, and deal with unforeseen emergencies. The type of debt you take on, as well as the amount and cost of it, can make the difference between good and bad debt. What makes good debt different from bad debt is that bad debts depreciate assets, while good debt can give you access to an asset that will increase in value over time.
You may have good debt in the form of a student loan that helps you afford an education that kicks off a lucrative career, a mortgage that eventually gets repaid and leaves you the deed for your house, or a business loan that gives you the capital you need to build of a successful company. Kantrowitz believes that a borrower has excessive debt on student loans when 10 percent or more of the person’s gross income is used to pay the loan. A simple rule for debt is that if it increases your assets or has a future value, it is good debt. However, since debt can have positive or negative consequences, it is usually considered a good or bad debt.
While debt has become a fact of life for most, it’s important to know that not all debts are created equal. In other words, if it doesn’t increase in value or generate income, you shouldn’t go into debt to buy it. Bad debts typically include any type of high-yield consumer debt that doesn’t matter much to you in achieving your long-term financial goals. In this case, taking on too many bad debts can make it harder for you to get out of the hole later on.
Debt puts unnecessary pressure on household finances and creates a lack of financial security for your spouse and children. Deciding to take on more debt is a personal choice and requires a bit of homework to determine whether or not you are getting more out of that debt than you invested. Here are general guidelines on good and bad debt, how to deal with each individual debt, and what to do if you’re facing too much debt.
References:
Barry Ritholtz is a renowned finance expert, author and blogger. With over 30 years of experience in the financial industry he has gained a reputation as a thought leader and influencer in the investment community.