Sometimes, no matter how well you plan, things unexpected things happen and they get out of your control, fast. Some of these situations often leave us needing financial help. Most people will take out a small loan or take on some other forms of debt as it is one of the easiest solutions to any financial trouble. What most people do not know is that there are two types of debt: good debt and bad debt. What is the difference between the two? Let’s explore.
Good debt is debt that will help you make an investment whose value will grow over time without burdening you with high interest. If you are asking how debt could be an investment, take into consideration the following examples:
- Student loans. These loans enable you to get a college education and your education actually increases your value as an employee. And depending on the course of your employment, education also increases your potential income.
- Another example is your home mortgage. Everyone needs somewhere to live. What better thing to invest in than your own home? In an ideal world, the value of your house should increase over time and would cancel out the interest your mortgage loan incurs.
- Small business loans is another good example of good debt. Taking out a loan that you can use to start or expand your business will help you increase your income and therefore can be one of the best investments you could make. This is, of course, contingent on your business savvy and sound decision making.
Bad debt is a debt incurred by buying things whole value and diminishes over a short amount of time. These are debts that also have high-interest rates.
- A good example is credit card debt. If you cannot pay your credit card balance in full every month, chances are something that cost you 50$ would end up costing you $60 because of interest. It is always a good idea to not leave a balance on your credit card. You will end up paying more than the actual value of the things you bought.
- Another bad debt is payday loans. These are short term loans that are quick and easy to apply for. However, the interest rates on these loans are ludicrous. Interest rates for payday loans could reach up to 400% of the loan amount.
- Car debt is also an example of bad debt. A car’s value will decrease over time, unless it is a collectible (which will probably cost an arm and a leg). Paying an exorbitant amount for a new car which will decrease in value is not a sound investment.
What should you do to avoid bad debt?
- Don’t leave a balance on your credit card. Make sure you pay on time to avoid any unnecessary penalties.
- Instead of a payday loan, take out a small personal loan from a reputable bank. Make sure that the loan you take out has a low-interest rate and is something that you can pay off fairly quickly.
- If you can pay cash for a second-hand car, consider that instead of getting a brand new one if it means paying in installments.