Good Debt versus Bad Debt

Where do I Begin?

When you look at your bills each month, do you feel overwhelmed by the amount of money that you’re spending on debt.  Understanding good debt versus bad debt is important.

Sometimes debt might seem like a trap.  Something you continually fight your way out of, but not all debt is bad.

Lenders look at your credit report to see what levels of debt you have and with who.  Some debts are more favorable than others. To get on the road sooner you need to understand Good debt versus Bad debt.

Good Debt

Good debt is borrowing money for the purpose of buying an income producing asset.  It can also be beneficial to borrow to further your education to increase your earning potential.  It is a good idea to look at that money as a loan that needs to be paid off when you are able to.

A good example of good debt, is a home or investment property purchase – this is an income producing asset. Since homes usually appreciate in value, the loan you take out to pay for the home is an investment.

I do not recommend borrowing money for the purpose of buying shares, I love the share market and own shares, but only invest what you are prepared to lose (a little like going to the casino!)

Bad Debt

Bad debt is purchasing a non-income producing asset.  Credit card debt is bad debt because of the nature of items that credit cards are used to purchase.

You should never accumulate debt to purchase everyday items like clothes or food. If you use a credit card for these types of purchases, you should pay the balance in full each month.

Borrowing money to finance a holiday is bad debt (Save for it instead – you will enjoy it far more knowing when you get back you are not going to spend the next six months paying the trip off).

We never consider buying a car with borrowed money, or bad debt.  Bad debt does not appreciate in value – in fact it most definitely decreases in value – rapidly.

Putting It Into Practice

Review your financial picture and find ways to start paying off your debts.  Start with your bad debts first (Credit Cards, Store Cards, Car Loans, Personal Loans etc). Since they provide no value or will not produce an income of any kind to assist your investment portfolio / personal goals growth), they’re more costly than your good debts.

Do not consider using more bad debt to pay off existing bad debt. One credit paying off another credit cards due balance. Unless, you are getting a new credit card at reduced interest or interest free period for a twelve month period therefore reducing debt.

Steer clear of adding extra to a mortgage when buying a property.

Have a look at all your debts and work out which one is costing you the most each month.  That is a good place to start.

You must still be careful that you don’t take on too much debt or over extend yourself. Even if it’s good debt.

Understand your risk profile You need to sleep at night.

If you would like to learn more about Getting Started Investing in Real Estate you can find our post here.