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Understanding Good Debt vs Bad Debt

Debt is a fact of life for most people, but not all debt is created equal. There are two main categories of debt: good debt and bad debt. Good debt is debt that can help you build wealth or increase your net worth over time. Bad debt, on the other hand, is debt that funds depreciating assets or is used to finance something that doesn’t provide a return. Here are some examples of good debt and bad debt:

Good debt:

  • Mortgages: A mortgage is a loan used to purchase a home. While it may seem like a large amount of debt, owning a home can be a valuable asset that increases in value over time.
  • Student loans: Taking out a loan to pay for education can be a good investment in your future earning potential.
  • Business loans: If you’re starting a business, taking out a loan to finance it can be a good way to invest in your future income.

Bad debt:

  • Credit card debt: Credit card debt is considered bad debt because it often carries high interest rates and is used to finance consumer goods that quickly lose value.
  • Car loans: While a car may be a necessary purchase, taking out a loan to finance it is considered bad debt because cars depreciate quickly in value.
  • Payday loans: Payday loans are short-term loans with high interest rates that are often used to cover unexpected expenses. They can quickly become a cycle of debt that is difficult to escape.

It’s important to note that even good debt can become bad debt if it’s not managed responsibly. For example, taking out a mortgage that is too large for your income or taking on too much student loan debt can lead to financial difficulties down the road.

When considering taking on debt, it’s important to weigh the potential benefits against the risks. Shop around for the lowest interest rates possible, research possible protections and payment plans available to you, and create a timeline to hold yourself accountable to your repayment plan. By managing your debt responsibly, you can use it as a tool to build wealth and achieve your financial goals.