That old adage “It takes money to make money” sums up the idea behind the phrase good debt. Taking out student loans to pay for a college education is a great example of good debt. So is getting a mortgage on a home or rental property or borrowing to fund a small business.
Loans for all of these have at least the potential to make money in the future as the business grows, you secure a higher salary because of a degree or the value of real estate appreciates. Of course, there is always risk even with good debt but the idea is that there is at least the chance for appreciation of the expenditure.
Students with large student debt realize the limitation of good debt despite the name because any debt may become difficult to pay. As those graduating in 2008 discovered, high paying jobs are not always available when you start looking for one. So, understand the risk involved.
Borrowing for a home is most likely the largest purchase a person will make in a lifetime, so it is critical to get it right. Take care to not buy house that is above your ability to comfortably pay. A home mortgage is one of the few ways the average person can leverage their money. Mortgages only require 20% down on the property and so in a strong housing market, the loan is worth the risk as long as the monthly payments can be made. The housing crisis left hundreds of thousands underwater on their homes and are still struggling to break even. Many mortgages especially subprime mortgages went into default so don’t forget the lessons of the recent past.
The opposite of good debt is bad debt. Debt used to finance DEPRECIATING assets such as cars and boats and goods bought with credit cards such as clothing have values that, for the most part, decline as soon as they are purchased. Credit cards that can’t be paid off every month are particularly damaging as interest on the debt accrues and compounds making that $100 sweater cost $150 or more.
An excess of any type of debt can be a burden that is difficult and maybe impossible to overcome. Always consider limiting debt whether good, or especially bad, when planning a budget. Your financial future depends on it.
Your debts are important when planning your investments.
Is your current advisor considering good vs. bad debt when managing your account?
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