Yes, you’ve read the title right! To those who don’t know, good debt exists just as much as bad debt does. It’s hard to imagine that good debt exists because of the negative discourse surrounding debt, but we assure you that good debt does exist, and it’s good to have it!
Many clients who come to Credit360 ask us, “how do I fix bad credit?” A credit repair consultant would then review all the bad debts that appear on your credit history. However, there are cases where a credit repair consultant would find good debt, which turned bad because the client was not managing their debt responsibly. That’s why when it comes to repairing credit, it’s essential to understand what type of debt you own and how to manage it responsibly. Thus, this blog intends to highlight the difference between good and bad debts while listing a few examples.
The main difference between good debts and bad debts is that good debt involves borrowed money spent on something that increases in value. In contrast, bad debts involves loans spent on something that goes down in value over time. Essentially, whatever you spend the loan on will determine if you have good or bad debts. Below we’ve listed some detailed examples.
Good Debt
When the borrower uses loans to purchase things that increase in value in the long run, the debt is considered good debt. Examples of good debts are student loans, home equity loans, and mortgages. These types of loans increase value in yourself, a small business, or a house. Once these debts are paid off, the borrower is left with something of higher value compared to the start. Below we go into further details about how the listed debts are considered good debts!
Student Loans
A student loan is a type of debt that helps a student pay for their post-secondary education. Student loans are considered good debt because the loan is put into an education where the student receives new knowledge and skills, which is used to help them excel in a future career where they make a greater income. For this reason, student loans are considered good debt because it grants access to a higher income.
However, student loans can quickly become bad debts if the borrower does not utilize their education to find a fulfilling career. As a result, student loan borrowers can easily fall into bad debts if their education does not grant them higher income to pay off the loan.
Home Equity Loans or Home Equity Line of Credit (HELOC)
A home equity loan is a secured loan, where the borrower uses their home’s equity as collateral in exchange for a loan. The loan amount is determined by the property’s value, calculated by the difference between the property’s value and the existing mortgage balance.
For example, suppose you owe $200,000 on a home valued at $350,000, then you own $150,000 in equity. The equity is then evaluated to determine the amount of the loan that you will receive.
Remember that a home equity loan is considered a second mortgage. That means, if the loan is not used responsibly to generate higher income, then you may find yourself falling into bad debts. That is why home equity loans should be used for things like opening a small business or as an investment tool. Also, what makes home equity loans good debt is the low-interest rates compared to credit card loans. All in all, we recommend not to use home equity loans to pay off other debts!
Mortgage
A mortgage is a type of loan used to buy a home or other properties. A mortgage is a secure loan because the property acts as collateral if payments are not fulfilled promptly. Mortgages are different from a home equity loan because a mortgage is used to buy the home, whereas a home equity loan is evaluated by a property already owned. Mortgages are considered good debt because once the debt is paid off, the house becomes your asset which will likely increase in value over the years.
However, if mortgage payments are not made promptly, this good debt can quickly become bad debts and a bad situation.
Bad Debt
As mentioned above, anyone can easily turn good debt into bad debt if the funds are misused. However, there are existing types of bad debts like credit card loans, auto loans, and payday loans. These types of loans are considered bad debts because they deplete in value over time. Thus, these loans are helpful for short-term use.
Credit Card Loans
Credit cards are helpful to make small purchases when money is not in hand. However, credit cards are typically used to purchase items that do not increase in value over time. At the same time, depending on how frequently a credit card is used, it can accumulate high-interest fees if payments are not made in full or on time. For this reason, credit cards are recognized as bad credit, and it is typically used as a tool to help build credit when managed responsibly.
Auto Loans
Auto loans are secured loans usually needed to acquire a car under a lease or finance agreement that authorizes regular payments. If these payments are not made promptly, then the vehicle is seized as collateral. Auto loans are considered as bad debts because regular payments are being made on an item that goes down in value. No matter how well a car is maintained, the vehicle goes down in value over time due to the car’s usage and the market’s supply of newer vehicles. For this reason, cars are often leased because you can always trade them in for a new car, whereas financing a car causes you to purchase an item that goes down in condition and depletes in value.
Payday Loans
A payday loan is an unsecured loan, which means the interest rates are extremely high. This type of loan allows the borrower to write a postdated check to the lender for a date when they will receive a salary, in return, the borrower receives part of the payday sum in cash from the lender in advance. These types of loans are considered as bad debts because they grant quick accessibility to cash with extremely high-interest rates. If a payday loan is not repaid on time, the borrower will be heavily penalized which means the lender can withdraw funds directly from the bank account. It will also affect the borrower’s credit score, especially if the debt goes to a collection agency. For this reason, payday loans are considered as a last resource loan.
At Credit360, we understand that identifying if you own good debt or bad debts could be tough. That’s why with our credit repair specialist, you can leave the worrying to the experts, as we will assess your debts for you! By choosing Credit360, you are choosing a service that has you covered!
Written By: Indojaa Sathiyaseelan
