Despite its bad rap, not all debt is bad debt. Some are actually beneficial for the debtor and considered “good debt.” Here’s a look at the factors defining good debt, the various types of good debt, and how to keep debt from going bad.
WHAT IS GOOD DEBT?
Good debt helps you build wealth or increase your net worth. Unlike bad debt, which includes long-term credit card debt and other high-interest debt that don’t add value to your financial situation, good debt is an investment that can ultimately pay off and benefit you.
TYPES OF GOOD DEBT
- Mortgages. A mortgage is generally considered good debt because it allows you to buy a home, which can appreciate in value. Each mortgage payment builds equity, which can be used as collateral for future loans or as a source of funding.
- Home equity loans and lines of credit. Another way to access equity in your home is through a home equity loan (HEL) or line of credit (HELOC). These allow you to borrow against the equity in your home for a variety of purposes.
- Student loans. Student loans are generally considered good debt because they can lead to increased career earning potential.
- Auto loans. An auto loan can be good debt if it helps you purchase reliable transportation for getting to work or to run a business.
- Business loans. A business loan can be considered good debt if it allows you to start or grow a business to generate income and increase your financial health.
CAN GOOD DEBT TURN INTO BAD DEBT?
Good debt can quickly sour if you miss a few payments or the investment goes south. For example, if you take on too much mortgage debt or buy a car you can’t really afford, you may struggle to make the payments and risk foreclosure. Similarly, defaulting on a student loan can hurt your credit score and lead to wage garnishment.
Be sure to consider the risks and rewards of taking out any loan and have a solid plan in place for repaying the debt before applying.
HOW CAN YOU KEEP GOOD DEBT FROM GOING BAD?
Here are some tips to keep your debts from going bad:
- Only borrow what you can afford.
- Choose loans with favorable terms.
- Make on-time payments.
- Monitor your credit score to check for fraud.
- Stay informed about changes in interest rates or other factors that may affect your debt.
