Separating Good Debt From Bad Debt

In the United States, debt is unfortunately an everyday part of life. The amount of debt in this country has been increasing year-over-year for decades and is the reason why credit card companies and other creditors have become big business. With the amount of debt however, has come a lot of opportunity for credit card issuers and other bad lenders to prey on those who charge more than they can afford to pay back.

On the flip side of that however, not all debt is bad. In fact, most Americans don’t realize that some debt is actually considered good and goes a long way in establishing a good credit history. When used responsibly, good debt can not only help your credit score but also help you build your assets and overall net worth.

Were the first steps in to take yours to be sure with your money is to be able to tell the difference between good debt and bad debt. The differences may seem obvious, many people fail to realize which is which.

Good debt

This type of debt includes things such as a home loan, school loans, real estate loans and business loans. This type of debt is also associated with investment and something that creates increased value. Home loans for example allow you to deduct the interest on your tax returns. So if you were to take back kind of debt and transfer your high interest credit cards over to that lower interest rate, you save money by deducting interest.

In a nutshell, good debt provides additional benefits that can actually make your financial situation better in the long term.

Bad debt

Bad debt comes in the form of things like high interest rate credit cards, store credit cards and car loans believe it or not. That is usually associated with the purchase of things that are used up or other tangible items that are purchased for material reasons. Usually these are bought with credit cards that have high interest rates associated with them.

Most people use these cards to charge more than they can afford to pay back over time. This causes a much more serious problem in that the game is that you make are only applied to the high interest rate if you make the minimum payment. Over time by making these types of payments imbalance never goes down.

Bad debt is also used to buy things that depreciate rapidly. A car loses 20% of its value the minute you drive it off the lot for instance. Putting your money into assets that depreciate is never a good idea however, it is a necessity in modern society.

The effect on your credit rating

If your personal debt is more than around 35% of your total income, it is possible that you will have problems getting new credit issued to you in the future. A good rule of thumb is to keep this ratio in mind whenever you are considering taking on new debt or applying for new credit cards. Another good rule is to ask yourself whether or not what you are buying will go up in value. If not, you can’t pay cash, it’s probably not a wise purchase.