More often than not, the advice we receive is that debt is bad. Though most adults are indebted in one way or the other, we view having debt as a type of personal finance failure. Undoubtedly, being nose deep in debt is bad for you, your family, and your credit score. But is it wise to categorize all types of debt as “bad debt”?
Understanding Good Debt Vs. Bad Debt
Consider the types of loans you may borrow in your life. Not all of these will affect your financial future similarly. Borrowing a hundred bucks from a friend in an emergency is different to taking out a housing mortgage. As there are different kinds of debts, it’s important to distinguish between those that help you versus those that ruin your financial future.
At first, it can be hard to fathom how debt can actually be beneficial. It all boils down to why you borrowed money in the first place. Ask yourself this question: did the loan you took out benefit you in a manner that helped you improve your life?
Consider a student loan. A vast majority of Americans graduate from college with hefty student loan debt. Let’s leave aside the cost of education for the moment, which is a separate topic altogether. Student debt is a huge financial burden for new graduates. But it’s also something that allows young people to receive a higher education. Data clearly points to a positive correlation between higher education and higher income levels.
Imagine someone who doesn’t take out a student loan to go to business school or law school. Their future earning potential with just a GED would very likely not reach the upper rungs. But with a degree, you can improve your ability to earn, pay back the loan, and enjoy a career that supports you for the rest of your life.
When to Take on More Debt, and When Not to
Certain loans like education loans, mortgages, or business loans can cause you to be indebted, but for a good cause. These loans provide you with something essential, such as permanent shelter. On the other side of this spectrum are the bad loans, which do not offer borrowers any tangible benefit.
Bad loans do not increase your income potential or offer you similar benefits. Rather, these loans entrap you in a cycle of borrowing and repaying. Think payday loans for example, which are attached to massive interest rates. Taking out a payday loan to buy groceries or a new TV would only put you in more debt. The groceries or the TV doesn’t increase in value over time, but the amount of debt you are in would.
Assessing All Your Borrowing Options
The way you borrow money can determine whether you take on good debt or bad debt. If you are borrowing money from an unlicensed local loan shark, you would certainly be in trouble. When you are in need of a loan, research all your options well. You can use a service like Loanable to go through a variety of options available. Considering multiple options will help you avoid bad debt and make you rely on respectable services.
You can also reach out to local credit unions or debt help groups for assistance. If possible, contact a lawyer before you sign a loan contract to actually understand what you are getting into.
You should aim to avoid bad debts that only provide you with assets that depreciate in value over time, like cars, gadgets, and similar items. Good debt provides you with things that only increase in value over time or never loses value, such as an education. In life, avoid all bad debts, and wisely take on good debt if necessary.