Updated: Oct 1, 2021
Have you ever heard the phrases, “good debt versus bad debt?”
What does it mean to you? Is there even such a thing as good debt and bad debt? Well, I’m here to share that YES there is such a thing. Let’s look at some examples:
A mortgage is a great example of good debt. A mortgage is used to help purchase a real estate asset. Traditionally, the asset will increase in value over time. Simultaneously, the mortgage is being paid down over time. At the end of the mortgage term, you are left with no debt and an asset that has potentially increased in value since the date of purchase. Also, in some cases, your mortgage interest payments may be tax deductible. It’s a win-win! Another example of good debt are student loans. While we could discuss the fairness of the cost of school or equity in the job market, we’ll leave that for a different time. The purpose of student loans is to give someone a chance to further their education while not having to pay the debt back until after graduation. The student can choose a traditional repayment schedule or income-based repayment options. Also, if the student decides to continue onto another education program, existing loan payments can be deferred. Finally, some student loan interest may be tax deductible.
Credit cards are a premier example of bad debt. Credit cards give us the ability to make purchases that we may not be able to afford otherwise. While most people can repay their credit cards without difficulty, some may allow credit card balances to get too high and repayment becomes difficult. What compounds the problem of repaying high credit card balances are the very high interest rates. Most of the clients I work with have credit card interest rates higher than 14%, and those are the clients with great credit! Additionally, high credit card balances have a negative impact on your credit score even if you make payments on time. Another type of bad debt are car loans. Many of us need to take out a loan to buy a car because cars are very expensive. However, let’s examine the ways a car loan is different from a mortgage. First, a car’s value will depreciate, or lose value, over time. That means when the loan is paid off, your car is certain to be worth less than it was when you bought it. Second, interest paid on a car loan is not tax deductible for individuals. Your best bet is to pay cash for a reliable vehicle rather than financing the newest model. I encourage you to find 0% car loan promotions where available.
All debt can be good or bad depending on how you use it.
A mortgage is considered good debt, but if you miss a payment it will negatively impact your credit score. A student loan has flexible repayment options, but the loan will continue to accrue interest the entire time you own it. Credit cards may be bad debt, but when used responsibly they are a great tool for building credit history. Car loans may also be bad debt, but for many of us they are necessary for our daily lives. If you have questions about your debt and ways it can be used to strengthen your credit report, please contact me.
All my best, Christina
Christina Gatteri, CFP
Certified Financial Planner
Warwick, Rhode Island 02886