According to a recent study, roughly 80% of Americans are in debt. While it is possible to maintain a debt-free lifestyle, there are benefits to being able to borrow money and prove your credit worthiness. So how can you distinguish between debt that is bad, and debt that you can eventually benefit from?
Good Debt versus Bad Debt
July 9, 2018
Credit cards especially are notorious for having high APRs. If you're holding a balance on your credit card and not paying it in full every month, you run the risk of snowballing into accumulating interest. The golden rule of credit cards is to only spend what you can pay back in full.
Using credit cards is a great way to build credit, increase your credit score, and benefit from lifestyle perks like airline mileage, cash back, and discounts at big-box stores. But the minute your credit card spending gets out of hand and you fall into credit card debt, you run the risk of damaging your finances in the future.
In your hunt for a credit card, there are a lot of options available. Sites like Credit Karma and Super Money are chock-full of comparisons, pros-and-cons, and other resources to help you find the perfect card, whether it's for travel points, cash back, or reduced ATM fees.
Very few people earn enough money to pay cash up-front for a real estate purchase. Even though mortgages are long-term loans (typically around 30 years), they generally have low interest rates. For many real estate markets, the value of your home increases over time. Mortgages are seen as a good debt, because you benefit from homeownership and a potential payoff if you sell your property after it increases in value.
Many of us rely on a car to get us around town or to and from our jobs. If your vehicle is essential to your lifestyle, taking out financing for your car can be essential. Unlike mortgages, however, auto loans tend to have a higher interest rate, and the value of a car decreases over time rather than increases.
For auto loans, it's recommended to pay off your financing earlier, otherwise you run the risk of getting into bad debt and making payments on a car that doesn't retain value.
PAYDAY AND CASH ADVANCE LOANS
If there's one rule around loans - it's that you should never take a payday or cash advance loan unless you absolutely cannot avoid it.
Why? Because these types of loans are known for producing the worst kinds of debt. The interest rate for these loans is obscenely high - sometimes as high as 100% - and payday loans are targeted at borrowers who have a history of missing their payments. Even if you take out a payday loan and are able to repay immediately, you're still on the hook for whatever fees the institute requires, and these fees are typically high.
LOANS FOR EDUCATION
Whenever you look into taking out any kind of financing, it's important to look at the value of whatever item you're going to purchase with your borrowed money.
If you take out a student loan, a new education is on the horizon, and that's wonderful. Student loans are a feasible and time-tested way to pay for your education over time.
When it comes to traditional higher education, bear in mind the outcome that you look to produce with your degree, certification, or training. Weigh the pros and cons to see if you're going to get a return on your education.
Depending on the quality and cost of your education, student loans can be seen as good debt or bad debt. Skills Fund is shaking this idea up by lending responsibly and only working with skills training programs that provide their students with a return on their education.
Unlike any other lender in the market, if we don't think a student will be able to pay back their student loan in a reasonable time, we won't give them a loan. It's that simple - because why should it be complicated?
HOW CAN I TELL THE DIFFERENCE BETWEEN GOOD AND BAD DEBT?
Two rules of thumb:
1. If you can't pay back your debt on time, you run the risk of accumulating interest and getting snowballed in debt.
2. If the item you are financing doesn't provide a return on your investment, think twice.