What is Good Debt?

 Jeffrey Low

March 5, 2020

Debt: We dread it, we’re scared of it and we want it out of our lives. Debt is universally one of the world’s ugliest words. It is commonly believed that any form of debt should be avoided. However, believe it or not, there’s can be such a thing as good debt. In some cases, debt can be advantageous for progressing in life. 

Defining Good Debt

In general, good debt is an investment that will appreciate in value in the long term and garner future benefits. Here are some examples, which when used properly, can be seen as good debt:

Student Loans:

Student loans can often determine whether an individual can attend post-secondary studies. Many are deterred from student loans because it would mean repaying tens of thousands of dollars right after graduation. However, earning a degree can lead to a higher-paying career, resulting in a more secure lifestyle. According to CollegeBoard, college graduates earn 67% more than high school graduates. 

Mortgages:

Mortgages are long term loans for purchasing a home, usually spanning 15 to 30 years. Despite having to pay monthly installments, the interest paid is tax-deductible and rates low compared to other forms of debt such as credit cards. Additionally, homes offer a place to live, rental income, and appreciate in market value over time. 

Home Equity Loans: 

A home equity loan oftentimes referred to as a “second mortgage,” is a loan against the existing equity of a home. If the loan is not paid in time, the financial institution has the right to claim possession of the property, known as collateral. While it may seem counterintuitive to borrow money against a home, especially if a mortgage is still being paid, home equity loans are relatively low interest, can be tax-deductible, and allow borrowers to access large sums of money in a short time frame. 

Small Business Loans:

Borrowing money to start or expand a business can increase future wealth if the business succeeds. Small business loans are beneficial for business owners since they retain the liberty to spend the money. Private investors may influence how the loan is spent and the direction of the company. Similar to all the other forms of good debt, small business loans also have relatively low-interest rates. 

What Good Debt is Not

On the opposite side of the spectrum lies “bad debt.” Bad debt is any loan used to make a purchase that provides no future return to the debtor and depreciates immediately after leaving the store. In nearly all cases, the interest on the debt is abysmally high and challenging to pay back. Some examples of classic forms of bad debt are:

Payday Loans:

Payday loan companies are notorious for placing interest rates of up to 500% on their loans and expect the debtors to pay it back before their payday. Time after time, debtors will have to borrow more money with high interest from the payday company to pay their existing debt, causing a perpetual cycle of debt. 

Credit Card Loans:

Credit cards are considered bad debt because they are the easiest to accumulate debt on. Many fall into the habit of using their credit cards to make unnecessary purchases but are unable to pay their balances before the monthly deadlines. If their balances are not paid in time, they are charged high interest, which is compounded over time if the debtor continues to miss their monthly deadlines. 

 

The Takeaway 

Regardless of the route you are seeking to obtain funds, it is of paramount importance to ponder the impacts of your borrowing. Consider whether taking the loan will offer future benefits or burdens and build a plan to pay the money back. Moreover, ask yourself what risks are involved with borrowing and if the purchases are a need or want. Acquiring a loan can change a life; whether it be in a good or bad way is up to the debtor. 

 

Disclaimer: If specific securities are mentioned they are for illustrative purposes only and such mention shall not be seen as a recommendation to buy and/or sell. None of the opinions expressed by Voleo or participating guests should be construed as investment advice. Securities offered through Voleo USA, Inc. Member of the Financial Industry Regulatory Authority (FINRA), Securities Investor Protection Corporation (SIPC). Security products are not FDIC insured, not bank guaranteed, and will fluctuate in value. We do not solicit, recommend, or offer investment advice. Voleo USA, Inc. is a wholly owned subsidiary of Voleo, Inc.