An Easy Guide to Understanding Good Debt and Bad Debt

The word debt has always had a negative connotation. A factor of its reputation is that debt payments cut into people’s available funds that they can use on groceries, trips, and bills payment. Another factor is that people hear about the consequences of having overwhelming debt—repossessions, bad credit score, or filing for bankruptcy.

However, debt can also bring something good to people’s lives. Loans allow them to purchase properties, move to better homes, or pay for their tuition even if they do not have the money at the moment. They can give people the freedom to live their lives to the fullest.

In hindsight, debt can be good, and it can also be bad. But what is the difference between the two?

Good Debt vs. Bad Debt

Good debts are those used to purchase items that will increase in value over time. Similarly, any debt that generates income and boosts a person’s net worth is considered good debt. By these definitions, mortgages, home equities, and student loans fall under this debt category.

On the other hand, debts people incur to purchase things that will only decrease in value as time passes or will not generate income in the future are bad debts. In this sense, loans for rent payments, credit card loans, and payday loans are deemed as bad debt.

Mortgages vs. Loans for Rent Payment

People have always viewed real estate as a good form of investment since it provides great returns, tax benefits, and more. In addition, property values appreciate over time. It means that the value of any property people purchase today is bound to be higher in the future.

Applying for a mortgage than a personal loan to pay rent is better. Although mortgages are long-term loans, mortgagors will own the property after they have finished their payments and build equity along the way.

On the other hand, loans for rent payment offer none of those. After addressing the loans, the debtor will neither own the home nor have any equity stored. Successful debt elimination may improve credit score, but that is about all the benefit there is.

Home Equities vs. Credit Card Loans

People use home equities and credit card loans on non-mortgage debts. But what makes home equities a good debt compared to credit card loans is the interest rate.

Home equity is the difference between property value and the balance remaining in the mortgage. More than 3 million Canadians enjoy a home equity line of credit (HELOC) that they can use to purchase anything at interest rates as low as 2.45 percent. Although people using HELOC can use their loans on anything, most would utilize their equities to pay for home renovations and student loans.

Credit card debt is thought of as bad because people use it to buy items with diminishing value over time. Aside from that, the interest rates are significantly higher than HELOC, with as much as 20.99 percent interest for purchases. That’s why debt consultants strongly advise against credit card loans.

Student Loans

Student loans are debts incurred to pay for post-secondary education tuition. They are perceived as good debts because anyone who takes out a student loan is expected to earn a higher salary in the future and even increase their net worth in the process. Additionally, student loans enjoy lower interest rates, much like mortgages and home equities.

Payday Loans

Professional debt consultants warn people against payday loans. Aside from not increasing a person’s net worth or generating income, payday loans have ridiculously high-interest rates for a relatively small amount of money borrowed. It puts people in a vicious payday loan cycle.

Conclusion

Managing debt can be a daunting task. However, understanding good and bad debts can help people make more informed financial decisions that are ultimately better. Living a completely debt-free life is a dream, but living a mostly bad debt-free life is more realistic.

Debt Helpers is a company that offers professional debt help in Canada for every person who aspires to live without debt. Contact us today for a free consultation!