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The Difference Between Good Debt and Bad Debt

Many people think that all debt is “bad” and that you should strive to have the least amount of it as possible. While there is truth to this in some ways, there are also certain types that can be considered “good” and healthy for your long-term financial health. There are a few reasons for this — good debt can help you generate income and build your net worth, whereas bad debt is money borrowed to purchase rapidly depreciating assets and can hurt your credit score.

What is Considered Good Debt?

In a broad sense, good debt can be anything that could improve your financial health, whether that is in the form of generating additional income or significantly improving your life in other ways. For example:

  • Purchasing a home/real estate — Taking out a mortgage to buy a home allows you to live in it, pay off the mortgage, and eventually be able to sell it for a profit in a strong market. It also enables you to build equity that results in tax breaks not available to those who rent. You can even generate income on a residential property as you pay down the mortgage by renting it out to other individuals.
  • Investing in education — While not always the case, investing in education generally increases an individual’s earning potential in the working world. It tends to lead to more opportunities for finding employment as well as a greater likelihood of securing higher-paying positions. It’s important to consider that not all degrees hold the same value, so you should evaluate the potential ROI of any education before taking on the debt.
  • Starting a business — While starting a business also comes with risks, it can result in great payoff over time if your business succeeds. A successful business can result in greater income, certain tax breaks, and other significant benefits if managed and sustained properly.

What is Considered Bad Debt?

Bad debt generally refers to a loan on any asset that quickly depreciates and will not go up in value. These types tend to have much higher interest rates that over time can negatively impact your credit score, including:

  • Car payments — It is not uncommon to need a loan to pay for a vehicle, but cars depreciate rapidly as soon as you drive them off the lot. If you must secure a loan for a car, diligently research your lending options, and look for the lowest interest rates available to you. Even though you’ll be investing in a depreciating asset, you may be able to save in interest.
  • High credit card balances — Any consumer goods you purchase like food, clothes, furniture, etc. are all necessary purchases, but it’s important to try to borrow as little as possible for these types of items. You should only use a credit card for convenience when you’re sure you’ll be able to pay off your balance at the end of the month, considering that credit cards have some of the highest interest rates of other types of loans.

How to Manage Debt

Good and bad debt are not one-size-fits-all — particular types may be beneficial to some and not to others. There are several ways to help manage any debt you do have, including building a comprehensive budget of your income and expenses to ensure you can afford your monthly payments. Based on your financial situation, you can identify what to pay down first, which would likely be your more high-interest debt.

Others use consolidation as a way of managing debt. This allows you to take out a new loan with a much lower interest rate to help pay off your other existing debts. It’s important to only use consolidation loans for repayment as using it for additional spending will only make paying off debt more difficult.

Have Questions?

Our team at Republic Bank is here to help with all of your financial needs. Reach out to us at 800-526-9127 or visit our website for more helpful guides.

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