Good Debt vs Bad Debt: How To Make Sure Your Debt Isn’t Hurting You

Is it better to have no debt? Or are there times when it is actually a good thing to take on debt? One thing is for sure, however. Not all debt is the same. The same is going to help you and some will hurt you.

There are times when you take on some debt so you can build credit and use it to your advantage, but what can happen is that you get into a vicious cycle. You can end up on a sort of hamster wheel of debt that causes you to take on even more. Before you know it, you are over your head.

good debt vs bad debt

The problem is that you have to know when the right moment is to take on some debt and how much to improve your financial future. How do you know? Well, in this article, we will go over several instances of when taking on some debt is going to help you and why. And then we’ll talk about the type of debt you should avoid.

Leveraging debt

If you have used a retirement calculator to find out what your retirement magic number is then you are probably trying to think of ways to speed up your savings. Since interest rates are so low right now, this is a perfect time to leverage some debt by taking out a loan to then use to invest.

This is one of the times that it makes absolute sense to take on some debt. In fact, many large corporations do exactly this because interest rates have never been so low. And the best part is that it can work even for an individual.

There is a high amount of risk, however, so do not go into this strategy lightly. You could lose the money you’ve borrowed and then still have to pay it back. When it is done right, though, you can make back much more than you borrowed. And once you are making those high yields, you simply use the dividends to pay off the loan itself and let the profits ride.

Education

Paying for education is an investment in that you are taking on some debt now that will pay for itself later based on your new skill set.

Though student loans can be quite high and take a long time to pay off, if you limit your other debts then you can pay it off faster and it won’t be a burden.

The more educated you are, the higher the earning potential. So there is an almost direct correlation between the education you receive and a higher salary. This is especially true when you are investing in technical education in a trade or something less academic.

Education is never wasted as job opportunities are easier to find when you have a degree or certification behind you. With one big caveat, however. You have to research what degrees have the most reward when it comes to finding those opportunities. A degree in Eastern Philosophy, for instance, is not going to provide the opportunity for a high paying job like a degree in Computer Science will.

Getting certifications is usually less expensive and can help find work that pays off the debt much faster than taking on a higher amount for a university degree.

Small business loans

It takes money to make money and when you hit a ceiling of earning in your business this means you need to borrow to grow.

Let’s say that you spot a gap in the market that your business is in. Nobody else is providing a solution to a certain problem that people are having so being the first would be a huge boon. But, you need to invest in some new machinery to do so. This is when taking a loan to buy that equipment is very good debt because it will help you make more money.

As long as the business loan is not being taken to pay the bills or stay afloat, then this is good debt. If your business is struggling, then that debt is going to be like an anchor around your neck and could speed up the demise of your business.

A loan should only be taken when you need to expand your business, or to make investments as was highlighted in an earlier section.

Real estate

Buying property is an almost essential debt. Unless you were very good with money as a teenager and can pay cash, there is little possibility to have a house without any debt. Now, even this debt is not all the same. You still need to think carefully about how you take it on.

For instance, if you are buying a very expensive house in a bad area with low property values, then this is likely going to cause you problems later. You may not sell the house for a good price if you need to move or retire.

Usually the debt from buying a house is simply because you need a place to live and even in this case, it is not considered bad debt. However, you can make your house purchase an investment that pays off dividends in certain situations. House hacking is a way to do this in which you buy a multiple unit building. You live in one unit and rent out the rest so you are essentially living for free.

Bad debt

Lastly, there are the types of loans that will put you in a bad position. Credit card debt should be avoided at all costs. Even if you are gaining points, you should pay off your bill every month.

Personal loans are also very bad. They often have high-interest rates and are difficult to pay off since little of the monthly payments go towards the principle. If you find yourself in a bad spot financially, try to avoid a personal loan at all costs and see if there is another way to come up with quick cash.