Know The Difference Between Good And Bad Debt

Credit Card Debt

Know The Difference Between Good And Bad Debt

Debt. Just the word alone scares many people. In fact, if pronounced hurriedly or with a certain accent, the word ‘debt’ might sound a lot like ‘death.’ Talk about a bum rap.

The truth is, there are two different kinds of debt. Debt is not always bad. Instead of something you worry about at the end of every month, it might actually turn out to be a tool you can use to boost your income and, indirectly, your standard of living. Just like with any other tool, it all depends on how you use it.

Debt can be good or it can be bad. There is no fixed list of good or bad types of debt. Instead, we’ll just list down the different characteristics you can use to determine between good and bad debt. Everyone’s situation is different so instead of cramming down a fixed list down your throat, you can use these guidelines so you can personally decide, using your particular information and situation, which debts you incur are good or bad.

Does it produce income?

This is a key point of difference between good and bad debt. Good debt helps put income in your pocket. For example, you will incur a huge debt when you buy an apartment building. However, if the building is fully rented out, the amount of lease income might exceed the amount of money you spent to buy the building in the first place. In this situation, you are looking at a good debt.

Compare this situation with you whipping out your credit card to buy a gaming laptop. The laptop packs amazing graphics and helps you play the latest and greatest in games. It doesn’t generate any income directly since you don’t use it for freelancing or home based business or other income-generating work.

Is it a bad debt? Not necessarily. Sure, it might not generate direct income. However, if it helps you relax so you can focus on the stuff that does put money in your pocket, then your gaming laptop is a key investment in your frame of mind. See how this works out? Don’t fixate too much on direct income production. Instead, see how it is related to income generation. Of course, the relationship must be direct and not just an excuse or justification.

Does it have a return on investment that beats your costs?

When you whip out a credit card or take out a loan to buy an income-generating asset, you are paying for the right to use somebody else’s money. This cost is called interest. You have to make sure that whatever costs you incur trying to generate money with your asset, as well as the price of the asset itself, is outweighed by the amount of money you make from the asset.

If not, you have just bought a ‘white elephant’-a project that you thought will provide tangible benefits but whose upkeep is actually costing you a lot and might put you under if you are not careful. Know the difference between an asset and a white elephant and an outright losing proposition.

2 thoughts on “Know The Difference Between Good And Bad Debt

  1. I do not like to characterize debt as good or bad, however debt associated with purchase of an asset such as a home or business will generally appreciate or earn income. Both good reasons to take on debt.

  2. I tend to agree with your new laptop analogy as being a possible good investment. If you do tasks on your computer to earn income but your computer is old and slow, you can do the same things faster on a newer computer and then possibly earn more money from it. I would invest in the newer and faster computer and then get more tasks done in a smaller amount of time.

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