Good and bad debt examples

Most people face debt from time to time, but often they do not know that there is good and bad debt, but this is true. While one debt can help you achieve your financial goals, another can make them much more difficult. Not only the type of debt taken but also its cost can influence how it affects your credit.

Thus, it is important to understand the difference between good and bad debt in order to achieve your financial goals. Explore some information on good and bad debt and how to handle both of them.

What is good debt?

Good debt is money owned for things that give you the opportunity to increase income or gain wealth over time. Thus, low-interest debt that helps you increase your income or net worth can be defined as good. However, it should be understood that any debt (both good and bad) should not be too big.

However, what are the good debt examples?

In order to better understand what good debt is, you need to study specific examples. Below are a few of them.

  • Student loan

A student loan is often a good debt as it can be seen as a kind of investment in your future. It is a student loan that gives you the opportunity to pursue an education that can lead you to wealth. Thus, student loans have lower interest rates. However, in order for a student loan to remain a good debt, certain requirements must be met.

It is good if your student loan payment does not exceed 10% of your estimated monthly salary (after taxes) one year after graduation. If you are unsure of how to deal with a large student loan debt, you need to create an income-based repayment plan and consider refinancing your loan.

  • Car loan

A car loan is also considered an example of good debt, as for many people a car is an indispensable part of life as it makes it possible to get to work or take children to school. However, in order for the debt to be considered good, you need to keep the loan payment within 20% of the monthly salary you receive. The loan term is also important and it is desirable that it does not exceed 4 years. If you find it difficult to deal with paying off your car loan, you can also use refinancing.

  • Mortgage

Of course, a mortgage is also considered a good debt, as it is not only the place where you want to live, but also an investment in the future. As you know, real estate is becoming more expensive and perhaps in the retirement age you will want to sell a large house, move to a small one and have a fairly large amount of money. In order to take out a mortgage, you must understand how big and expensive a house you can afford. It is recommended that the mortgage payment be up to 36% of your income. Also note that relocating to a less expensive area and refinancing may help you deal with your mortgage.

What is bad debt?

Bad debt is any consumer debt that can do little to improve your credit. Thus, expensive debts that undoubtedly worsen your financial situation can be classified as bad. If you take out a loan to buy an item that is of little value or loses it quickly, that is bad debt. Also, if you take out expensive credit cards and loans with a high or variable rate - this is also definitely a bad debt.

Also, as already mentioned, even good debt can turn bad if you are not good at budgeting. If you take out any loan at high interest rates, it can lead to the fact that you will not be able to repay the debt in the future and your credit history will be worsened.

By looking at specific examples of bad debt, it will be easier for you to understand what it is and how you can avoid it.

  • Personal loan for purchases

Of course, getting a personal loan to afford the latest bag, expensive clothes, a vacation you can't afford, or birthday dinner at a fancy restaurant is not only bad debt but a waste of money. Moreover, such debt is addictive. If you once allowed yourself something that you could not buy before, you will want to continue. Thus, you will fall into a debt trap and very soon you will not be able to cope with your financial difficulties.

Of course, this does not mean that you should completely forget about personal loans. This example is about unnecessary purchases or things you can live without. You can take out a personal loan if you need emergency help or want to consolidate debt, then that makes sense and wise.

  • Payday loan

You probably know that most payday loans have extremely high interest rates. Thus, even if you borrow a small amount, the interest will be so high that it will be difficult for you to cope with the loan. The short payment terms (on the day of the next paycheck) further complicate the situation, since you will have to return the money in just one month. Just imagine having an interest rate of 300%. This debt is not worth it. In many cases, people who take payday loans cannot repay them, so they have to pay a late payment fee, which only gets bigger. This is a debt hole that can be quite difficult to get rid of.

If you are in a difficult situation and you need several hundred dollars to paycheck, you should not think about a payday loan - this is clearly not the best option and there is a big risk that you will not be able to repay the loan. Instead, ask friends or family for help, and as a last resort, contact lenders with minimal interest rates.

  • High interest credit card

Many people do not even think about how much they overpay using high-interest credit cards. Of course, if the interest rate on your card is more than 20%, your debts become more expensive and it becomes more difficult for you to pay off. Moreover, most people do not use credit cards to cover emergencies, but to buy new clothes, gadgets, and other things they don't need to buy.

Many people who want to pay off credit card debt are faced with the fact that they pay as much as they can, but the debt does not go away. Of course: this is due to high interest rates.

What can you do? If you have the opportunity, then contact a financial advisor who can continue you with several ways to solve the problem. If you do not have the financial ability to do this, you can take out a personal loan and consolidate the debt. If you compare the offers of different lenders, you can find the one that offers the best interest rates. Thus, it will be easier for you to pay off a low-interest personal loan than a card debt with a 20% interest rate.