When to go into debt is good (and how to avoid too much)
Not all debt is created equal, and how and why you choose to borrow money is crucial to maintaining financial health.
Financial experts often separate debt into two categories: good debt and bad debt. The difference between the two is that one group can help improve your financial health over time while the other can make it worse.
Even if you only focus on good debt, it’s still important to avoid taking on too much. Here’s what you need to know.
What is good debt?
Good debt is generally characterized as a type of loan that offers a relatively low interest rate and can help improve your financial situation. Examples include:
- Mortgages: Home loans have some of the lowest interest rates you can get, and they allow you to buy an asset (a house) that appreciates in value over time. You can compare mortgage rates to maximize your savings through Credible’s free online tools.
- Student loans: Federal and private student loans, for the most part, have single-digit interest rates. And if you need it to finish college, getting a degree can provide you with opportunities to earn more income.
- Auto loans: Auto loan interest rates may be high for some people, but they are still low compared to other types of consumer debt. Although cars generally depreciate over time, owning a vehicle can be critical to your ability to work or attend school.
- Home equity loans and lines of credit: These loan options are usually low interest because they are secured by the equity in your home, and you may be able to use them to consolidate debt or make improvements to your home to increase its value.
- Debt Consolidation Loans: Personal loans can be used for just about anything, but when you use them to consolidate credit card debt and other high interest loans, they can save you money. Shop around for the best rates using Credible now.
GOOD DEBT VS. BAD DEBTS: WHAT’S THE DIFFERENCE?
While these types of debt can be useful, it is always a good idea to reduce the amount you borrow.
For example, put money on mortgages and car loans, and if your budget allows, go for shorter repayment terms. With student loans, try to find other ways to pay for your college education that don’t require repayment, such as scholarships, grants, and a part-time job.
What is bad debt?
Bad debt usually comes in the form of high interest loans that do not improve your financial situation in the short or long term. Examples include:
- Credit card: Finding the right credit card can help you take advantage of special features like rewards programs, zero percent promotions, and more. But if you don’t plan to pay off your balance in full each month to avoid interest charges (many cards charge rates above 20%), it may be best to avoid them and credit card debt.
- Personal loans: Using a personal loan for something other than debt consolidation or emergency spending is easy, but it can do more harm than good to your financial situation. It is possible to get a personal loan with a single digit interest rate, but many lenders charge more than 30% for people with below average credit.
- Short-term loan: These loans come in the form of payday loans, auto title loans, and short-term personal loans. Not only do they have exorbitant interest rates, often triple digits, but they also have short repayment terms, which makes repayment more difficult.
For some people, it can be difficult to avoid bad debt. But, if possible, make a goal of eliminating this type of debt and avoiding it in the future.
HOW DOES DEBT CONSOLIDATION AFFECT YOUR CREDIT RATING?
How to best manage your debt
While not all debt is bad, that doesn’t mean you want a lot of it in your life. The best way to manage your debt is to build and maintain a great credit history. The higher your credit score, the lower your interest rates will be, regardless of how you borrow money. Lower interest rates and lower payments can help keep your debt from being collected.
Plus, whenever you are considering borrowing money, take the time to compare rates and other terms before making a decision.
HOW TO ELIMINATE $ 5,000 OF CREDIT CARD DEBT
Finally, if you can, take steps to pay off your debt faster than your expected repayment terms. This strategy can save you money on interest charges and open up more cash flow for other important personal financial goals.