Debt is the amount of money one party owes from another party. You borrow money to purchase goods or services that you could otherwise not afford at the moment. However, you borrow with the promise to repay the funds with interests in the future.
This definition makes it seem like debt is neither good nor bad. A closer look at the concept of debt, however, can reveal that it could have either positive or negative consequences. These consequences depend on how you use the money that you borrow.
Understand how Debt Affects Your Credit Score.
- Good Debts
Good debts create value and help you increase your net worth. Some examples of good debts are housing loans, real estate loans, education loans and business loans. All of these have the potential to generate income over time.
- Housing Loan
Not many people can afford to pay for their houses with cash. With a housing loan, you can pay for your home through relatively low monthly payments over a long period. Usually, this type of debt has a lower interest rate compared to other loans. In an ideal situation, the market value of your house will increase enough to cover the interest being paid on loan. Aside from the low-interest rates, the interest for housing loans is also typically tax deductible.
- Real Estate Loan
Similar to the market value of a house, the value of a real estate property has the potential to increase over the years. Both residential and commercial real estate can also be a source of rental income. In this sense, real estate loans can be considered as investments.
- Education Loan
Education can boost your earning capacity. A good education can expose you to more employment opportunities and can give you a better chance at taking a shot at these chances. Moreover, this type of loan typically has an easy repayment method and low-interest rate. Read more here.
- Business Loan
Business is another income-generating endeavour. With a successful business venture, you will not have to rely on another party for a pay cheque. Being the head of your own business can also motivate you to work harder than ever. However, you may need a capital to jumpstart this business. Since such endeavour has a great potential to build your wealth, a business loan can be considered as a good debt.
- Bad Debts
Conversely, bad debts are used to purchase goods and services that have no potential to increase your net worth.
- Credit Card Debts and Store Credit Card Debts
Credit cards are usually used to purchase disposable items that easily lose value over time. The same goes for store credit cards. If you do not pay the balance in full, the amount you are paying for the items continues to increase due to the high-interest rates even while the market value of the items goes down.
- Auto Loan
Vehicles are liabilities and not assets. In general, vehicles are depreciating items. This means that they lose their value over time. Auto loans, however, may also be considered good debt if the vehicle will be used for income-generating purposes such as a business.
Armed with the understanding between good and bad debt, try to determine which kind of debt you currently have to manage your finances better.
Here’s how you can Take Account of Your Debts.Recommend0 recommendationsPublished in