About now you may be thinking that all debt is bad, but it isn’t. Some debt is a good investment in your future.
For instance, a student loan is considered a good debt. Not only are student loans generally at a low interest rate, the purpose of the debt is an investment. By using the borrowed money to achieve a higher education, you’ll increase your earning power.
Buying something you need for your business would also be considered a good debt. For example, if you need a new piece of equipment or a delivery truck in order to improve your business – or in order to continue doing business – then you’re making an investment and improving your ability to earn an income. On the other hand, upgrading to a fancier cell phone or a nicer desk would be a bad debt.
Your home mortgage has always been considered a good debt – until recently. In the past, home prices were rising so you were building equity in excess of your loan payments each and every month. You were saving money by putting it into your home rather than paying rent. But we’ve all seen that prices can go down, and consumers can be badly damaged by adjustable rate mortgages.
Right now a mortgage would still be considered a good debt if the price is right and you can get a low interest, fixed rate mortgage.
Another good debt would be a low-interest home-equity loan used to make improvements to your home that will add to its value. A new roof, for example, would be considered an investment in your home.
So what is bad debt?
A typical example is credit card debt – especially credit card debt incurred to purchase non-essential items. If you’re paying 15-20% interest on a credit card and charge $200 to go out for a night on the town, that’s bad debt. If you’re making minimum payments on your credit card, that dinner will cost in excess of $250 – and you have nothing to show for it.
Car loans are considered bad debt because cars begin to depreciate in value the minute you drive them off the lot. And if you trade them in before they’re paid off, you’ll often find yourself owing more on the car than you can get for a trade-in value.
Payday loans are really bad debt. They do serve a purpose for someone in an emergency situation – such as needing a car part tonight in order to go to work tomorrow. But when used regularly to meet everyday expenses between paydays, they’re a trap.
The finance charge for a payday loan can range from $10 to $30 per $100 – and they’re usually only for a week or two. Even at $10, that comes to about 240% annual interest. Worse, if you can’t repay them on time the lender will extend the time period and double the interest, along with adding extra fees!
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