Good Debt Versus Bad Debt – Do You Know the Difference?

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While being indebted is generally a hindrance when it comes to building your wealth it is a common misconception that all debt is bad.

Your debt can be split into ‘good’ debt and ‘bad’ debt. Good debt is debt that helps you generate income and helps you grow your wealth while bad debt is debt that is a strain on your  finances  and prevents you from increasing your net worth.

Good debt

Student Loan

A good education can go a long way, especially when it comes to building your wealth. Investing in your future is a great way to spend money so a student loan would be considering as good debt as it will yield you a high return in the long run. As strenuous as student loans can seem on your net worth in your 20s if you are not able to get a scholarship or have your parents fund your education a student debt is a necessary investment.

Real Estate

Taking out a mortgage on a buy to let property is a great example of good debt. You find a property of good value in an area that you believe will see property prices rise and buy the property using debt to rent it out. That way you have a stream of income that pays off the property and perhaps even generates monthly cash income for you.

Start Up Loan

Taking out a loan to start a new business would also be considered good debt. If you don’t have the capital to launch your new business idea taking out the required capital in the form of a loan is absolutely acceptable and can turn into a very lucrative investment for yourself. Provided, of course, the business succeeds and you are able to pay back the loan in full without late payment.

Bad debt

Consumer Loans

The biggest and unfortunately most common form of bad debt are consumer loans. Buying a new flat screen TV or an expensive luxury holiday on debt is something that absolutely needs to be avoided if you want to grow your net worth and move towards financial freedom. If you can’t afford to pay for it in cash, then you cannot afford it!

Cars

The same goes for buying a new car. Yes, if you need a car to fit the whole family or your car broke down and a you need one for your commute then it is OK to buy a car. But avoid buying a new cars as their value drops as soon as you leave the drive way of the car dealer ship. Making a smart second hard car buy that is good value is the way forward when it comes to buying a car.

Real Estate

I have put real estate in the good debt section above, whoever it should also be mentioned in the bad debt section. Getting a mortgage on a buy to let property which you will rent out as an investment would be good debt but when it comes to buying a house to live in I would argue that that is bad debt. If you are buying a big house to live in and you are only able to afford a small down payment you really should not be buying it in the first place because that mortgage will prevent you from taking positive financial risks in life as you are always constrained by having to pay your mortgage. This is in my opinion the primary cause of why people work jobs they hate. It is simply to pay for their mortgage.

Ideally you would want to pay for everything in cash but that is not an option for everyone. So when you do in debt yourself make sure it is good debt and not bad debt.

Source by Alex Lielacher

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