What Types of Debt Are “Good” or “Bad”?

What Types of Debt Are “Good” or “Bad”?

Grant T. Gallagher, Financial Wellbeing & External Affairs Manager, Affinity Federal Credit Union

The word “debt” doesn’t have an inherently positive ring to it. But it describes something that millions of us have.1 As much as we would prefer to be debt-free, we live in an economy where some degree of debt is often essential to both survival and long-term financial wellbeing. Distinguishing between good and bad debt is key to making the right financial decisions. At its core, it is a question of whether the debt you are taking on is an investment or a liability. The answer isn’t always clear-cut.

We tend to think of “good debt” as something that increases our personal future earning potential, e.g., education, home ownership or starting a business. By contrast, “bad debt” is when we are on the hook for depreciating assets, like a car, or the ultimate ‘financial death spiral” – large-scale credit card debt. But things become murkier when you consider the inherent risks of taking on debt to buy a home or business, and how even depreciating assets can provide indirect rewards. So, what types of debt are good, bad or in a grey area?

dollar bills

Education
Sizable student loan debts have become common, and necessary, as college degrees become less of an edge and more of a requirement in the job market. Education raises your earning potential, but that doesn’t make all student loan debt good. Over the years, the soaring cost of a college degree has weakened2 the overall return on an investment. That return also varies significantly by the type of degree, with science and engineering credentials paying off higher than liberal arts degrees, for example. So, overall, it’s good to take on debt to acquire education, but do research beforehand on your degree’s earning potential and the overall state of the economy.

Home Ownership
Like student loans, mortgage debt is usually considered an investment rather than a liability. At the outset, home investment can spare you from upwardly spiraling rents. In the longer term, property values typically rise over time and high demand for housing in major urban areas can result in greater return when you sell your home. But buying a home that’s too much of a “fixer-upper” can see the costs outstripping the benefits. You should also pay close attention to the area where you buy – though property mostly appreciates in value, not every town and neighborhood is on an upward trajectory. Finally, make sure that you’re getting the best possible mortgage rates; Affinity is a good place to start looking.

Starting a Business
Though society sees entrepreneurialism as a good thing, taking on huge amounts of debt to go into business for yourself is much more of a grey area than student loans or mortgages. About half of all small businesses fail3 within the first five years. Every case is different; it depends on your own expertise, the market you’re trying to satisfy and dozens of other factors that can’t be addressed within this blog. But before going into debt, be as certain as possible about your chances for success.

Auto Financing and Loans
Depreciating assets are typically viewed as “bad debt” because there is no direct return on your investment. But as with the “positive” examples above, these “negative” examples aren’t necessarily absolute. It’s best to avoid taking on debt to buy cars; pay in cash if you have it, even at the risk of having to tighten your belt for a while afterward. But you do need a car to get to work or to job interviews. So, occasionally it’s an indirect investment to finance a car that you wouldn’t normally be able to afford. Why risk losing a job due to lack of transportation – or having to ultimately pay more money for ride hailing services or public transport – rather than getting an affordable auto loan?

Credit Card Debt
Anything purchased on a credit card can also fall into either category. Are you taking advantage of a great rewards program attached to the card and paying off that bill in full? In this instance, since you’re not even paying any interest, or “carrying the balance,” you’re not really accumulating debt at all. If you’re financing your dream vacation on your credit card with no plans to pay beyond the minimum for months, or even years, again, this is “bad debt.” If you do find yourself in credit card debt you can’t seem to get out of, consider this option. You can apply for an Affinity debt consolidation loan. This option often allows you flexibility with lower interest rates, lower monthly payments, and only one simple payment a month.

What Types of Debt Are You Racking Up?
There’s no simple, straightforward answer to the question of what kind of debt is good or bad beyond the basic principle that it’s good if it’s an investment and bad if it’s a liability. Use your discretion and consult financial advisors. Pay close attention to Affinity’s expert advice on such issues as recovering from holiday debt splurges and how to adopt the best consolidation plans. But remember that any kind of debt is bad if it means you risk default or bankruptcy.

                                                   

This information is for informational purposes only and is intended to provide general guidance and does not constitute legal, tax, or financial advice. Each person’s circumstances are different and may not apply to the specific information provided. You should seek the advice of a financial professional, tax consultant, and/or legal counsel to discuss your specific needs before making any financial or other commitments regarding the matters related to your condition are made.  

1 Retrieved from https://www.debt.org/faqs/americans-in-debt/
2 Retrieved from https://www.forbes.com/advisor/personal-finance/whats-the-return-on-a-college-education/
3 Retrieved from https://www.investopedia.com/financial-edge/1010/top-6-reasons-new-businesses-fail.aspx