Loans have helped many to improve their financial position, while others have fallen into deep problems due to the same loans. While it is possible to live an entirely debt-free life, avoiding loans can hinder your ability to own your dream home or car or start a business that could positively change your life. Therefore, a loan can both be a good and bad thing at the same time. The main difference is the reason you are taking out the loan and how you put the money to use after acquiring it.
The first thing to do is note the differences between your wants and your needs. In this case, if you borrow money to cover for your needs or buy things that appreciate in value, then that’s good debt. If you borrow to cover your wants or buy things that depreciate, then that’s bad debt. The following examples of both good and bad debt will give you a clearer distinction between the two.
1. School Loans
Using a loan to pay for your education is good debt because once you acquire your academic degree, you will be able to earn more money in your lifetime. It’s something that qualifies you for a certain job over those who lack such qualifications. Therefore, borrowing to pay for your education or child’s education is rarely a bad decision.
2. Home Loans
Being a homeowner is commendable. Unfortunately, not everyone can afford a home at the moment, and while taking out a mortgage loan may be daunting due to the size of the loan, this is typically a good decision. Truman Advisors argue that rather than continue paying for rented housing, that same money can be put toward a home loan and be used to build equity. A mortgage is a good example of good debt and can be a smart financial decision depending on your unique situation.
3. Auto Loans
Some people’s lives are more convenient with their own car, especially when public transport is not available or is unreliable. Buying a car often becomes the only option, and if you cannot afford it, you will be required to take out a car loan. An auto loan can be both bad and good debt. The deciding factors are the type of car you buy and the way that it’s used. A used car with low miles that helps commute to work and make a better living is good debt, while a new Ferrari used to drive to the mall is bad debt.
4. Business Loans
They say it takes money to make money and this is why in most cases borrowing money for business is justified. However, make sure that you borrow with a good plan and have great business prospects so that at the end of the day, the business generates more income than the initial expense. According to Truman Advisors, a business loan is good debt if, and only if, you are purchasing or paying for something that brings more money to the business.
1. Loans for Discretionary Expenses
Taking out a personal loan to be able to pay for vacations, buy expensive clothes or jewelry or any other discretionary item is bad debt. You should either save for these things naturally or wait until you can boost your income, but never borrow.
2. High-Interest Credit Cards
Credit cards provide their holders with the ability to make purchases anytime they choose, regardless of whether it’s a need or a want. This freedom of spending using borrowed money makes credit card bad debt. Unfortunately, almost every American has a credit card, and it makes them feel like it is easier to afford an item using a credit card than using cash. The bad news is that it is hard to get out of credit card debt and it is better if you do not acquire it in the first place.
3. Payday Loans
Most companies that provide payday loans charge excessively high interest rates because they know many people are desperate for cash. Truman Advisors says that you should be very careful because paying off these loans becomes very difficult. A payday loan is one of the worst forms of bad debt, and even if you desperately need a short-term loan, it is better to exhaust all other options rather than relying on such companies.
You will more than likely find yourself borrowing at some point in your life, and it is good you understand the difference between good debt and bad debt. Watch out to avoid falling into deep debts that could have been avoided in the first place.