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Good Debt and Bad Debt

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Discharge your obligations to all men; pay tax and toll, reverence and respect, to those to whom they are due. Leave no claim outstanding against you, except that of mutual love –8 (The New English Bible).

There can be good debt as well as bad debt. Good debt can be described as debt that helps you build equity or increase your net worth. For example, education loans usually are considered good debt because in the long run more education generally translates into higher earning power. Most people borrow money for a mortgage to get a home—if the home purchase was a wise investment that increases in value and adds to your net worth, then it would be considered good debt. Another example of good debt might be loans to run a small business—for example, if you borrow money at 7 percent and use that money to make a 15 percent or 20 percent return, then it would be considered good debt because you are using the loan to increase your net worth. Good debt includes loans that help to build your financial future.

On the other hand, bad debts are the ones that negatively impact your financial future. Bad debt might be described as obligations that last longer than the purchase item and ones that have no return toward increasing your net worth. Before making a purchase via a loan, ask yourself is this good debt or bad debt—will the debt help to increase my net worth or will it decrease my net worth? Avoid as much bad debt as possible. The Financial Planning Association suggests that total debt should not exceed 10–15 percent of your take-home pay—excluding mortgages. Many credit experts recommend that debt should not exceed 25 percent of disposable income. Over indebtedness can push you to the maximum to repay your debt while still trying to maintain daily living expenses. A sudden unexpected event such as a job downsizing, divorce, a death in the family, an uninsured accident, theft, a large tax bill, or a major medical expense can have tragic results to your finances and result in a credit crisis. A major unexpected event combined with insufficient savings and insurance can easily result in a credit crisis. Assuming credit loans is something you want to avoid if at all possible. Few things are worth borrowing for. Avoid going into debt for rewards such as vacations or fancy restaurant meals; save for them and pay cash. Borrow as little money as possible and at the lowest interest rate possible.

Most debt can be avoided if you take action to live within your income. Consumer Credit Counseling Services stated that the number one cause of money problems with their nationwide clients was poor money management including impulsive spending. Practice delayed gratification—earn the money before you spend it. Save for purchases if at all possible until you can pay cash or use debit cards for them. When you borrow money, you pay interest plus the principal borrowed, so items purchased end up costing you much more than the original price. Practicing delayed gratification until you can pay cash saves you the added cost of the item and has less negative impact on your future net worth. Studies indicate that consumers generally spend about 25 percent less when they pay cash for items. This is due to the savings on interest charges and the fact that you waste less money on impulse purchases due to the temptation and convenience of credit cards. Many impulse purchases are for items you do not even need.

Forty percent of people pay off credit card purchases in full every month—the other 60 percent would benefit from making changes in their spending habits. If you purchase only what you can pay cash for, chances are you are in control of your financial life. You may be overextended if you cannot pay all of your debt—excluding mortgage—in 18 to 24 months. If you pay only the minimum amount due on your outstanding credit cards month after month, you might stay in debt indefinitely since most of the payment goes toward interest. You definitely have a credit problem if you cannot pay all of your monthly minimums. You should eliminate nonproductive, expensive debts as soon as possible.

“ The rich lord it over the poor; the borrower becomes the lender’s slave” (The New English Bible).

 

 

 

 

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