Differentiating Between Good and Bad Debt

You must be able to tell what makes a debt good or bad.

A number of people believe that any kind of debt is bad. But if you consult an expert in personal finance, he will tell you that there are good debts and bad debts. You might be surprised to know that all mortgages are considered to be good debts but not using them wisely can easily turn them to bad debt. Usually, loans with monthly repayments are considered to be good and other debts like credit card come under the category of bad debts. Explained below are a few kinds of debts and also the reasons what make them good or bad:

Student Loans – Education is always expensive but if you complete it, it pays well too. Obtaining student loans are not too difficult but if they are not repaid in time, you may find it very difficult to discharge the debts. To ensure that it is a good debt, borrow a reasonable amount of loan so that when you begin to earn, you are able to pay it off.

If the amount borrowed is too much as compared to what your salary will be, ensure that you finish your education so that you can begin earning and repaying your debt.

When you apply for an auto loan, remember that the loan amount should not exceed the value of the car.

Auto Loans- Most people cannot afford to pay in cash when they buy a new vehicle and so, they get it financed. If your vehicle is essential for you and you use it for all important things, then it is a good investment. It becomes a good debt when you get the loan at reasonable rates of interest and you are able to repay it timely.

It becomes a bad debt when most of your income is used to repay the loan and you are left with no extra funds for repairs, maintenance and other expenses.

Home Mortgage – This is by far the most important debt that a person avails in his life. A home mortgage is considered to a good debt that improves a person’s credit greatly when used properly.

The ideal total monthly payment should not exceed 36% of your monthly income.

As with the auto loan, even in this case, the loan amount should not exceed the value of the house. It should be an asset that appreciates in value with the passage of time. This is what makes a home mortgage a good debt. The combined value of the loan amount, the taxes and the maintenance should not be more than your monthly rent. If the monthly expense is more than your rent, it becomes a bad debt.

Credit Cards - Credit cards are not usually considered as good debts but you can use them to your advantage if you use your cards wisely. There are always numerous schemes like low interest finance or 0% interest finance available for credit card holders. These times make use of credit card a good debt. Use it to pay for your essentials and not to splurge. If your credit card debts leave

Use your credit card to purchase essentials and keep your savings intact to be used in times of emergencies.

you wanting more cash each month, it becomes a bad debt.

Complete your education and don’t let your debts take you underwater so that you struggle to breathe. When you are availing home loan, do not use it to buy distressed property where the investment will be more than the returns. Also, remember not to borrow more than you can repay. If you follow these tips, you will be able to turn all loans into good debts that will improve your credit.