
Not all debt is necessarily bad, particularly when it can help you build wealth. In this blog, we’ll explore the crucial differences between good debt and bad debt, and provide you with the knowledge to make informed financial decisions. From understanding how a mortgage or student loan can be beneficial to recognizing the pitfalls of high-interest credit card debt, we’ll guide you through sorting the good from the bad. Join us as we delve into strategies to leverage debt effectively, ensuring it supports your long-term financial goals and contributes to a secure, prosperous future.
What is bad debt? What is good debt?
If you buy something that immediately goes down in value, that’s bad debt. Let’s say you buy disposable items or durable goods with a high-interest credit card, and you don’t pay the balance in full when the bill arrives. You’re being charged interest while that item continues to depreciate and lose value, so that’s bad debt. On the other hand, investment debts that create value—such as real-estate loans, home mortgages, student loans, and business loans—are examples of good debt.
What about taking on more debt to reduce current debt? A tax-deductible home-equity loan at 6% is considered good debt if you can use it to pay off a credit card with an interest rate of, say, 17%. Of course, the key is not to run those debts back up. What about auto loans? You might think they’re always bad debt because most cars go down in value, but if you take out an auto loan for a car that gets better gas mileage than your old vehicle, you could be better off financially.
What’s the best type of debt?
An example of good debt is mortgage debt because home values generally increase. The current national average appreciation rate is 14.5% per year. Homeownership is one of the best ways to build wealth over time. Other strategies for building wealth include:
- Set “smart” goals (specific, measurable, adjustable, realistic, and time-oriented).
- Pay yourself first and automate your savings using payroll deductions.
- Establish an emergency fund and take advantage of credit union savings vehicles, like savings accounts, money market accounts, certificates of deposit, youth savings, college funds, and holiday club accounts.
- Understand basic investing principles, such as compound interest, risk, diversification, dollar-cost averaging, and asset allocation.
- Reduce your debt. Start by paying off high-interest credit card debt and avoid late fees. Paying your bills on time makes up about 35% of your credit score.
Free financial counseling from White River Credit Union
White River Credit Union offers free Financial Counseling to help our members reach financial wellness. Whether you’re aiming to better manage your budget, plan for the future, or navigate financial challenges, our expert counselors are here to provide personalized advice and support. Schedule an appointment today and take the first step towards financial well-being with a neighbor you can trust.