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Good Debt versus Bad Debt

The unwise use of credit cards usually leads to the accumulation of debt. As a result a lot of money is spent each month on the bills needed to cover such a debt.

However, debt is a complex concept. Not all debt is bad. In fact, when used intelligently, debt can be a great tool for building wealth. Therefore, smart financial planning requires you to discriminate between good debt and bad debt.

What is Bad Debt?

The kind of debt that worsens your financial situation is the one that is accumulated on the expenses for items that are immediately consumed. This means that the nature of the items that you purchase with your credit card qualifies the type of debt you accumulate.

Thus, the purchase of such goods as food and gas is not recommended to be done with your plastic. If you however prefer to pay for such purchases with your credit card, then at the end of the month you should completely cover the bills.

There is a basic rule of thumb you can follow in order to avoid bad debt: if you want to buy something that does not increase in value but you cannot afford to pay cash, then you just cannot afford to buy it.

What is Good Debt?

Yes, debt can be good. This is in case when you use your credit card to pay for items that are likely to appreciate in value and thus is considered as an investment. An appropriate example for good debt is the purchase of a house. This is so, since homes usually increase in value over the long-term.

Even loans for college financing are considered good debt, since after you graduate you will make money thanks to the education you have acquired. Thus, such a loan can be also classified as an investment in yourself.

Therefore, in order to accumulate good debt, not a bad one you should examine its results over the long-term.

Good and Bad Debt Management

When you decide that it is time to cover some of your debts, you should first analyze the financial situation you are in and group your debts into good and bad. After this you should embark on covering the bad ones first, because they come at a higher cost and do not provide further value. For example, covering your credit cards should come first in the list.

One technique for coverage of bad debt applied by some people is the taking of a mortgage of a higher amount than needed. Thus, they use their good debt and particularly the money that is left from it to cover the accumulated bad debt. However, we don't recommend this, because what you actually do is using one debt to cover another. Additionally, you will have to spend more time on covering your mortgage. You will also have to make higher monthly payments.

Paying off debt by incurring another debt is never a good idea no matter what type it is. Thus, it is always better to find cash for the putting down of bad debt.

No matter in what category the debt falls, you should be cautious and try to avoid accumulating too much debt, because it will have a negative impact on your financial situation.

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