Today, we have a guest post from Amy Nickson.  She’s here to talk about what kinds of debt are good, and what kinds of debt are bad.  Enjoy the post!

Good & Bad Debt: Know them well to remain risk free

Debt is painful; but you cannot deny it in your life. Very few people are able to pay cash to get life’s most important purchases like a home. The most vital thing that you have to decide before taking out a loan is whether or not the debt incurred is good or bad.

So, if you know the difference between what is good debt and what is bad debt, you’ll easily be able to make the right decision related to incurring debt.

What is good debt?

A good debt is anything that helps you make money later in your life and help you against any financial shortcomings. These can be investments, loans for businesses, student loans, mortgage, etc. Suppose you invest in a real estate property or in gold, you’re depositing a certain amount of money to invest in these things. You have to buy a house or a land for investment purpose so that if the value of the property or land increases, you can sell off the property to get back the money you spent as well as extra money. The money invested grows and helps you earn extra money.

You may need to take out a mortgage to buy a house or refinance the mortgage to make some renovations to your property. These all increases the value of your home or helps you build equity in your home for future use. If you take out loans for starting a business of your own, you’ll be able to repay them with the profit you earn from your business. Good debt also helps your credit score to improve if you manage your personal finances well.

What is bad debt?

Unlike good debt, bad debt always puts you in such a situation where you cannot make any money. If you default on your good debt payments such as business loans or mortgage, it may turn into bad debt. If you’re unable to pay back your mortgage, you may need to opt for foreclosure or short sale. In both the cases, your credit score suffers a lot and foreclosure remains for 7 years on your credit report.

Examples of some bad debts:

1. Payday loan debt:

There are plenty of reasons for payday loans to be popular. These are instant cash relief for people who are in a tight situation. Payday loans are very easy to obtain. Most payday lenders operate online and all you have to do is log onto a payday loan website, fill out an application form and submit it. The eligibility criteria are also pretty simple.

But, taking out a payday loan should be avoided because it is considered as a bad debt.

Why?

The above-given advantages overshadow the one big disadvantage of payday loan i.e. if you’re not able to pay it back on time, you start to gather very high interest on the loan. Usually, the time period of payday loans is 15 – 30 days. You should repay the loan within the stipulated time.

However, when you can’t pay the balances on your next payday and keep rolling them, you end up having a high amount of debt.

2. Credit card debt:

If you have a lot of credit card debt, it is also considered as bad debt. You must also avoid paying through store cards as the rate jumps to 20% or more after few months and the consumers are not informed about it. Also, there is a certain credit limit in every credit cards. If you use more than 30% of available credit, then your credit score will get a major hit.

The most important rule of managing credit card debt is not opening any more credit card accounts after you’ve incurred debt. Try to pay for your expenditures by cash and don’t charge your cards unnecessarily. When you pay by cards, try to make the payments in full so that you don’t incur any more bad debt.

3. Automobile debt:

Taking out an automobile loan is also considered as a bad financial decision because in the future, usually a car has very low resale value, since a car depreciates with time. Depreciation is one of the biggest disadvantages of buying a car. The longer you own a car, the less resale value you will get due to wear, tear, and the environment. A car doesn’t increase value like a home with time.

However, you need a car to commute from one place to another, especially if you live in a city where public services are not much available. So, it’s better not to purchase an expensive vehicle, since the loan amount will also be high.

If you’ve taken out an auto loan, you need to make timely repayments on it to avoid an imminent repossession. So, If you take out a fatter loan to buy a car and fail to repay it,, you may lose the car. While, if you take out a home loan and fail to make repayment, then you can go for short sell for foreclosure.

So, it depends on you how you will manage a debt. You can make a bad debt a good one by managing it properly.

Author’s Bio: Amy Nickson is a web enthusiast. She completed her graduation from Oglethorpe University, Atlanta, Georgia. She works as a financial writer and she shares her expertise through her crisp and well researched articles based on money management, money saving ideas, debt, and so on. You can follow her on Oak View Law Group where she shares her expertise on personal finance field.