You may have heard of "good debt" and "bad debt".
In other words, not all debt is equal, and not all types of debt are necessarily bad.
But first, you need to understand the difference between good and bad debt, and how good debt can actually turn into bad debt.
What might be considered good debt? Think about things that can be considered investments in yourself or in your future financial security. For example, getting a mortgage for a home that will appreciate in value, at a rate that is reasonable and doesn't stretch your finances too much, is good. Some educational debt can be good if you're getting a degree that you're positive will open new opportunities for higher paying jobs after graduation.
Good debt is debt that can help you build wealth over time or increase your earning potential. It usually has a low, steady interest rate and fits nicely into your budget. Good debt is often an investment in your future financial health.
Bad debt, on the other hand, is debt you take on that's unnecessary, at a high interest rate, or unsustainable. For example, going on a shopping spree and putting it on a high-interest credit card that you can't pay off right away is bad debt. Buying a nicer car than you can afford at a high interest rate can also be considered bad debt.
How does good debt turn into bad debt? It often happens with student loans. Some people assume that more degrees will automatically lead to higher pay, only to end up with $200,000 in student loan debt and no job, or a job that doesn’t pay enough to manage those payments. The same thing can happen with housing. A mortgage with a high interest rate or a home that doesn’t increase in value can become a financial burden. Likewise, a home equity loan used for improvements can turn into bad debt if the monthly payments are more than you can afford.
What are the signs of bad debt? Before taking on debt, you should ask yourself whether the debt is helping you build wealth and improving your future, or if it's just funding a temporary lifestyle upgrade.
There are three big signs you should pay attention to:
- High interest rates. Credit cards that you can't pay off every month, payday loans and some personal loans (if you don't shop around), can be considered bad debt.
- Lack of lasting value. Debt for things like impulse buys, dining out routinely (not only for special occasions) and clothing that won't last more than a season are not smart spending.
- Debt that strains your budget. If you're juggling payments, missing due dates, only able to make minimum payments, or using debt to pay debt, that's bad.
So, how do you get out of bad debt? CommonWealth One has several articles and free webinars on how to get out of debt, including which "methods" might work best for you. Here are links to a few of those:
- 5 Common Debt Payoff Mistakes to Avoid
- Slaying Debt: A Guide to Paying Down Debt and Building Wealth
- Resolve to Get Out of Debt
In addition, we'd be happy to set up a meeting between you and one of our certified financial professionals to walk you through ways you can reduce your debt, whether it's by creating a sustainable budget, refinancing loans or automating payments. We're just a call or click away (message us through online banking).
We're here for you, for life, through good debts and bad
