What’s the difference between good debt and bad debt? In this post (Good Debt vs Bad Debt), you’ll get a detailed explanation.
If you look around, you will find yourself surrounded by people with home loans, car loans, credit card bills, and student loans. Debt is an essential element of sound financial planning.
Staying away from debt may keep you loan-free, but it is detrimental to economic growth. Good financial planning concerns the nature of debt you accumulate and how you pay it off.
Therefore, it is essential to understand the difference between good and bad debt.
What Is Good Debt?
Good debt is a loan you take to help you generate income and increase your net worth. Such a debt is considered positive and an investment in your or your family’s future.
Sometimes you may take out a loan to purchase a big-ticket entity that will increase in value over the years, such as a piece of land, a house, or even an education. Such things contribute to your financial health by generating income and are known as good debts.
What Is a Bad Debt?
Bad debt is a loan that you avail for purchasing something you will consume or something that will depreciate. In other words, any debt that does not increase your net worth or generate income for you is called bad debt.
Bad debts include loans to buy cars, clothes, and consumables. It is the kind of debt that creates an unhealthy financial situation.
What Is the Difference Between Good and Bad Debt?
The simplest way to describe the difference between good debt and bad debt is that if it increases your net worth or income, it is good debt. If it doesn’t do that and increases your bills, it is bad debt.
Here is a look at some of the differences between good and bad debt –
|Good Debt||Bad Debt|
|Good debt is like an investment||Bad debt is not an investment, but an expense|
|Good debts help in purchasing things that will increase in value||Bad debts are used to finance items that will be consumed|
|Some examples of good debt are home loans, education loans, and car loans||Some examples of bad debt include credit card bills and high-interest loans|
Related: 10 ways to save money
Examples of Good Debt
Here are some examples of good debt to help explain the concept better.
- Mortgage – A home loan to build a home for your family and yourself is a good form of debt. Buying a home is also an investment, as the value of your home increases with time.
- Student Loans – A good education helps increase your income potential. It helps improve your career prospects and helps secure a prosperous future. And therefore, a student loan is also considered good debt.
- Car Loans – Even though cars depreciate after they leave the showroom, car loans can also be good debt if the purchased vehicle maintains its value even after you pay off your loan. A car loan may also be considered an investment if your vehicle helps expand your business or gets you a better-paying job.
- Business Loans – A loan or funding to start your business or increase the scope of your business is also a good debt. If you are passionate about your business and knowledgeable, your business loan may work as a stepping stone to success.
Examples of Bad Debt
Some examples of bad debt are listed below –
- Credit Card Debt – Credit cards are usually used to purchase consumable items such as food or clothes and to pay bills. But accumulating credit card debt by spending on everyday items may result in bad debt.
- High-Interest Loans – The financial market abounds with high-interest financial instruments such as payday loans, unsecured loans, credit cards, and personal loans. Such loans can land you in a debt trap. Loans with very high-interest rates should only be taken as a last resort.
How to Focus on Good Debt & Avoid Bad Debt
Like all skills, learning good financial planning also takes some time. If you want to learn how to focus on good debts and avoid bad debts, you must be ready to unlearn a few things from the past and adopt a new financial mentality.
The first thing to do is research and learn the difference between good and bad debt. When opting for a loan or debt instrument, read the fine print and calculate the risks.
Plan and devise a debt payoff strategy to payoff your bad debts first, as they may cost you more. You can also consider taking a private personal loan to repay your debts quickly. You can also avail of a debt consolidation loan to promptly pay off your bad debts.
Spend your earning years balancing earnings and debt can help you build substantial equity. Apart from the examples mentioned above, personal and consolidation loans also fall under good debts. All you need to do is focus on good debt and avoid bad debt as best as you can.
Author Bio: TanviKaushik specializes in Content Marketing and works with the Digital Team at KreditBee – India’s fastest personal loan platform where self-employed and salaried professionals can easily avail of personal loans in just a few minutes when in need of quick funds. Tanvi writes to-the-point articles on personal finance and budgeting which are truly appreciated by her readers.
She is committed to making money matters easy to understand even for the layman. Her commitment to her work doesn’t stop her from pursuing her hobbies of hiking, trekking and going on adventurous trips.