Good Debt, Bad Debt
It’s no surprise that more young adults are shying away from financial risks. It’s been drilled into your head that debt is bad, often with family horror stories about how much debt your parents had to overcome, or maybe never did. Unfortunately, those same lessons that were meant to teach you frugality have instilled some bad habits and perhaps some unnecessary fears. The key is understanding that there are really two kinds of debt: “good debt” and “bad debt.”
According to Experian.com, a debt is good if you have a “reasonable expectation of lasting benefit from your purchase and repayment terms that are fair and affordable.” Bad debt, on the other hand, involves “borrowing for purchases that don't have lasting value, taking on excessive debts that outpace your ability to keep up with payments, and payment terms that bring financial hardship.”
Good debts typically have low-interest rates. They are investments that have the potential to increase your income, net worth, or that have a future value.
Mortgages: One example of a “good debt” is a mortgage. The idea is that a well-maintained property will steadily increase in value. You could potentially sell the house for a profit or you may use the property to generate additional income by renting it out.
Business Loans: Taking out a loan to start or expand your business is generally seen as a good debt. A successful business can provide a constant source of income for your life, allowing you to support yourself and your family.
Student Loans: By investing in your education, your goal is to secure employment in a career that pays more than you would have otherwise earned. However, too much of any debt can be a bad thing. When it comes to student loans, a good rule of thumb is not to borrow more than you expect to earn in your first year on your job.
Auto Loans: Whether an auto loan is a good or bad debt depends a lot of your individual circumstances. For many people, a reliable car is essential to get to work and earn a living. When financing a car, you may want to pass on the new expensive, luxury vehicle that will depreciate as soon as you leave the dealer’s lot, and choose an affordable used vehicle that will meet your needs instead.
Credit Cards: Many people use credit cards to pay for entertainment, travel, leisure, dining, or shopping to earn rewards. Rewards cards have their perks, but only if you are disciplined enough to pay the balance in full each month. Otherwise, that debt can stay with you for a long time, particularly with the high interest rates young people have to endure.
High-interest Loans: High-interest rates on personal loans and the astronomical fees and finance charges associated with payday loans can make it challenging to repay these debts. Instead of helping, these loans can put borrowers in a more difficult financial situation.
If you are struggling with bad debts, what can help? One option is to consolidation your debt into one loan with favorable terms. For example, some choose to take out a lower-rate home equity loan or line of credit to consolidate high-interest credit card or personal loan balances. Contact floridacentral to discuss if this consolidation option would benefit you. Another option is to seek credit counseling. floridacentral partners with GreenPath to offer financial counseling and debt management assistance.
Avoid taking on bad debt altogether by building up your emergency savings. This will help you avoid using credit cards or personal loans to cover unexpected expenses. Another tip is to postpone entertainment and leisure purchases until you have set aside enough money to pay using cash.
Debt does not have to be a bad thing! Carefully consider what types of debt you are taking on and the terms of the loans. When used responsibly, credit can help you achieve your goals and improve your future.