Not All Debts Are Bad. How Do You Differentiate Good Debts From Bad Debts?

Good Debt Vs Bad Debt

Is debt ever “good”? Whenever we think of debt, all sorts of negative connotations pop up in our heads. However, not all debt is “bad” — some forms of debt are even considered “good”. So, what’s the difference? How do you know if your debt is “good” or “bad”?

Good debt helps you amass valuable assets

The first key in identifying whether a debt is good or bad is to know whether it boosts your wealth. That sounds a little paradoxical doesn’t it? Believe it or not, some forms of debt can help you become wealthier in the long run.

Take home loans for example. Debt you get from getting a new property can be considered as good debt because it builds your net worth. Overtime, the value of your property is going to increase and in the long run, you’ll stand to become wealthier.

Good debt opens new opportunities for you

Most of us have taken a student loan to pay for our university education. Despite knowing the high costs, we still incur the debt anyway because we know that having a degree is going to open new opportunities for us. Your starting pay is higher and you’ll have more career advancing opportunities too, which also means you’ll have higher lifetime savings.

Because of this, the benefits of having a degree outweighs the cost of incurring a debt from student loans. Debt that opens new opportunities for you to earn more and do well financially can also be considered good debt.

Bad debt gives you little to no long term gain

On the flip side, bad debt is drastically different from good debt because it leads to no long term financial gain. Swiping your card on clothes, food, the latest iPhone, or a manicure are all forms of bad debt.

But, why? Aren’t these goods lower in cost than a student loan? Bad debt and good debt aren’t differentiated by how much it costs. Rather, they’re differentiated by the long term financial benefit you gain from incurring debt. Items like the latest iPhone or Play Station will depreciate in value overtime. Loans from buying yourself a car also fall into the “bad debt” category because the price of your vehicle immediately depreciates the moment you’ve made your purchase.

A simple way to consider whether the debt you’ve incurred is “good” or “bad” lies in whether it helps you improve your financial health. If the asset or goods you’ve purchased depreciates in value overtime, chances are, it’s a form of bad debt.

The grey area

It’s easy to establish what good and bad debt is in theory. However, in the real world, it isn’t always so straight forward.

In general, debt that improves your financial standing in the long term is considered as good debt — student loans and housing loans are common examples. However, this assumes that having a degree will definitely land you a better paying job with better prospects. Or that having a loan to renovate your property will definitely attract buyers or tenants to your property.

In reality, these outcomes may not be as predictable. “Good debt” can only be considered “good” when your renovated property increases in values and attracts buyers, or when your degree lands you a job with strong prospects.

Debt isn’t always “bad”. To improve your financial health, you’ll need to be financially savvy and understand basic concepts of debt in order to make the best decisions. Remember — being financially healthy doesn’t always mean spending less to save more! It’s about spending wisely on assets or skills which bring you value in the long run.

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