When Is Debt a Good Thing?

February 6, 2020

People often have strong opinions about debt. Many are strictly anti-debt, and others see little downside to borrowing money. In reality, debt is a nuanced subject and can be helpful or detrimental depending on the specific type, terms and your unique situation.

Although we believe there are “good” and “bad” forms of debt, it’s important to state that we don’t recommend you borrow even “good” money unless it’s necessary and beneficial. If taking on debt will allow you to purchase or invest in something that will grow in value or increases your net worth, it is “good” debt. If it doesn’t add value or the cost of acquiring it is too high, it’s not “good” debt.

Typically, mortgages and education loans are good debt – provided the education is in a field that will provide good earning potential. Debt consolidation loans can also be helpful as they lend flexibility and comfort to a family’s financial life, which allows you to save regularly and stay on a budget. They might also help lower interest rates and the total cost of borrowing.

When we think about “bad” debt, credit cards come to mind first. In a perfect world, we wouldn’t have any credit card debt as they typically carry high interest rates and are used to purchase goods and services we didn’t need or that won’t add value. Other types of “bad” debt are loans used to purchase things beyond our means – like a car that’s too expensive or a store credit card to buy shiny new appliances.

Even if we’re conscientious about borrowing money, it’s not unlikely we’ll end up with some amount of “bad” debt in our lives. If we do, it’s critical to prioritize and manage debt properly, and here are a few tips to do so:

Pay off high-interest debt first, especially credit cards or high-interest vehicle loans.
Snowball your payments. Once you’ve paid off a “bad” debt, use that money to grow the amount paid on the next. By increasing payments, you’ll pay off debt more quickly.
Don’t spend beyond your means. Credit cards should be treated like debit cards that happen to help build credit. Don’t carry a balance and earn interest. Always pay the amount in full, and if you can’t afford it, don’t buy it.
Consolidate loans. If you have debt at varying interest rates, look at options for consolidating. The goal is to have an interest rate lower than the collective interest rate of existing debt.

Not all debt is bad debt, but all debt must be managed. Use your financial resources wisely, don’t spend beyond your means, and if you must take on debt, be sure it adds value or flexibility to your life.

 

Blog by Andrew Gaskill, Financial Services Manager.

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