When you hear the word debt, what comes to mind? If you’re like most people, you automatically associate the word with a negative emotion. We’re taught at a young age that debt is something to avoid. But when it comes to quantifying debt, there are two forms to consider. Not all forms of debt are bad. In fact, there are some types of debt that are actually good to have. In this article, we explain the difference between the good and the bad and how good debt can actually help you reach your financial goals.
What is Bad Debt?
Just about everyone has some form of debt. Bad debt comes in many forms, however they all have the same end result, which is creating a negative cash flow and hinders your financial growth. Credit cards with high interest rates are a perfect example of bad debt. Unless you’re able to pay double the minimum payment, the interest keeps accruing. This often results in you paying more in interest than the actual number of purchases. In fact, there are times when the amount of interest paid over time can exceed the credit limit.
If you find yourself in this uncomfortable position, you need to create a payoff strategy. You can try the snowball method, which means you pay off the cards with the lowest balance first. You then move onto the next card and repeat the process until you reach your last credit card. If you have outstanding medical bills, you need to set up a payment plan. Ignoring them will only lead to you being harassed by collections agencies and having a negative mark on your credit that may not fall off until years down the road.
Examples of Good Debt
Good debt is a type of debt that is good for your financial portfolio. It builds your credit worthiness and can help you obtain a variety of financial instruments throughout your lifetime. Student loans, for example, can be a form of good debt. When paid on time, low-interest student loans can boost your credit score and show that you’re financially responsible. Having good credit is especially important if you have children who need help paying for college. With good credit, you can apply for a low-interest private parent loan and give your child an opportunity to thrive.
Mortgages are another example of good debt. However, it’s important to note that with a mortgage, you never want to bite off more than you can chew, even if you’re approved. It’s not uncommon for those with high annual salaries to be house poor. Even though it looks like they can afford it on paper, when combined with their other expenses, they don’t have much left over at the end of the month. In some cases, they could be in the red. Your mortgage payment should never surpass 30% to 35% of your total income. If it does, you can try refinancing and lower your monthly payment, look for other ways to cut corners, or even consider selling your home.