People usually associate debt with financial difficulties, overspending or unemployment. But debt isn't always a bad thing.
Sure, it is easy to slide into a pool of debt when hard times hit, but borrowing money can just as easily be a stepping stone towards financial freedom.
The big difference between good debt and bad debt lies in the way you spend the money you borrow. Is that money going into investments, or into liabilities?
When a lender checks your credit history to see if you are good for the money, the different types of debt that you have will affect their decisions in different ways. A mortgage won't usually raise a scowl like a huge credit card debt would.
Good debts are debts that make sense. For example, if you borrow money to invest in your financial future. Everybody understands that taking a loan makes sense sometimes. With good debt, there is a clear and specific reason for getting the loan. The repayment schedule should also make sense here, and should fit your income.
Here are some examples of loans that could be considered good debts:
A student loan is (ideally) an investment in your future and should pay off in the form of an increase in your income. As long as you have a clear plan and sufficient income to meet your repayments, lenders will usually pay less attention to this kind of debt.
A mortgage is one the largest loans that most Americans borrow in their lifetime. But property is historically a good investment, as long as you don't buy in a bubble (during a property boom). If you buy wisely, your home can be one of your greatest assets, earning you rent or saving you rent. Most properties increase in value over time, so getting a mortgage is generally looked on as an investment.
Business LoanBorrowing money to expand your business (or to start a new one) is usually part of the process of succeeding in business. Sure, you can bootstrap your business or find an investment angel. But for most entrepreneurs, getting a business loan is the most realistic option. As long as your business is growing and you are meeting your repayment schedule, this debt will be more of an investment than a liability.
Bad debts shouldn't need much explaining. These debts are unnecessary and unsustainable, and are responsible for the ball-and-chain image usually associated with debt. These debts don't make sense because there is no clear plan for repayment. Rather than being invested, this money is just spent. In the end you might not even know where it went.
Here's my blacklist of debts that you will want to avoid like the plague:
Credit Card Debt
Americans are knee-deep in credit card debt, but this kind of debt is totally unnecessary and is easy to avoid. Carrying a balance on a credit card is never a good idea, unless you are using a low interest credit card to pay off a large purchase or balance transfer without paying interest.
Many credit cards have high APR's (Annual Percentage Rate) and usually compound interest regularly, so you can pile up loads of debt much quicker than you think. Always pay off your credit card bill in full each month to avoid paying the APR!
The best thing you can do is to have your credit card bill deducted from your checking or savings account automatically. That way you can avoid this kind of debt altogether. I recommend you use a credit card that you can link to your bank account.
Getting a personal loan is more difficult than getting a cash advance from your credit card. That's a good safeguard because it will probably make you think twice.
Be sure you have a good reason to get the loan, and take time to work out a concrete plan to repay the loan. Even if you make your payments on time, getting too many personal loans does not look good on your credit history
You might be one of those lucky car owners who always resells your cars at a profit. Unfortunately the vast majority of people are not, and because of that, most lenders consider car loans to be liabilities.
Consider saving up for your next car, and stick to cars that you can really afford. If you do get a car loan, make sure the repayment schedule fits with your income like peas and carrots. That car of your dreams won't seem as much fun if the only place it gets you is into debt.
If you have debts and are struggling to ward off the flood of interest charges, you should consider using a low interest credit card. Aim for a card that offers a long introductory period with as little as 0% APR for a certain amount of time.
This is one of the most effective ways to consolidate your debt and put a plug in the interest cash drain. Some cards even let you make balance transfers without paying a fee.
Here are some of my favorite credit cards with intro APR offers on purchases and balance transfers: