You must have heard about the saying – No Debt is Good Debt! Yes there are debts that can rapidly depreciate your assets. But there are also a few debts that add value to your life, by helping you purchase certain big-ticket items that you can’t otherwise afford. So, essentially there are good debts and bad debts.

Now that you know about the classification of debts, it is time to proceed to the part where you can identify good debts from the bad ones.  This could be a very easy task at certain times; but there will be debts that you will find tough to categorize. Your focus will have to be on your individual financial situation if you need to determine whether a particular debt is good or bad. Nevertheless, here is a standard classification of good debts and the bad debts:

Good Debts

The definition of a good debt is simple – If a particular debt that you take is helping you generate income and build net worth, it can be considered as a good debt. In other words, a good debt can improve the quality of your life. Here are a few things that can make debt-taking worthwhile:

Education

An education loan is definitely a good debt since it increases your earning potential. Getting enrolled into a good college or university can increase your career options and help you find better paying jobs. Within a short span of entering the workforce, you will be able to clear all your debts and lead a quality life.

Small Business Loans

In case you are borrowing a loan to start your own business, this can also be a good debt. Owning and running your business is definitely a lot of hard work; but it also makes it that much more rewarding, both financially as well as psychologically. Yes, it does come with risks; but if you start something that you are passionate about and do all the required research, you can achieve great success.

Home or Real Estate Loan

If you were to take out a mortgage to purchase a home, you can enjoy living in it for a couple of years and then sell it off for a profit. You can also buy commercial or residential real estate and generate income through rent. By taking a loan for your primary residence you can also enjoy the various tax breaks that are not available to the renters. Also, you don’t necessarily have to make a 20 percent down payment. You can get an FHA loan for as low as 3.5 percent down payment. Get in touch with a few FHA lenders through FHA live transfer leads to find out if you qualify for one.

If you already own your home, you can take a home equity loan, a HELOC, or even a reverse mortgage to make some renovations and increase the value of your home.

Bad Debts

In case you are borrowing money to purchase an asset that will depreciate in value, it is definitely a bad debt. A bad debt can decrease your quality of life and even take you towards bankruptcy, if you are not too careful about spending money. Here are a few examples of bad debts:

Automobile Loans

It might make sense to borrow money to purchase a car, if you aren’t able to live without one. However, the fact is that the moment your car leaves the store where you purchased it from, it starts depreciating in value. If you still have to borrow, it is better to apply for a loan that comes with low or no interest.

Credit Card Debts

Although credit cards make it convenient for you to make your purchases, it can spoil your financial health. The heavy interest that you pay here will be your silent killer. Unfortunately, not all realize the kind of money that they end up paying in exchange for the privilege of using a credit card. This can bring down your credit score unless you restrict your credit card usage to less than 30 percent of your available credit. If you are feeling happy about the Credit Card reward programs, think again. It might be an extra incentive for what you spend; but the interest charges that you pay will more than offset the value that you get from these rewards.

Payday Loans

If credit cards are bad, payday loans are worse. No doubt they are quick and easy in getting you some short-term cash whenever you are going through a crisis. All that you need to do is give a post-dated check to pay off the balance from your paycheck (after two weeks). But the charges that you pay would be anywhere between 15 to 30 percent of the money that you borrow. That sums up to an Annual Percentage Rate (APR) of 400 percent.

Special Considerations

While some debts are easy to classify, there are others that might be good for some and bad for the others, depending on various factors including their financial situation. These include:

Debt Consolidation Loans

If you are already in debt, you can take out a debt consolidation loan to pay off your existing debts. You can get such a loan at a lower interest rate when compared to your credit cards. You may also be able to save some money on your future interest payments. However, you need to make sure you don’t use the cash for any other purpose other than paying off your debts.

Borrowing Money to Invest

If you are an experienced investor in a brokerage firm, you may be having a margin account that you can use to purchase securities. However, if you are not too careful you can end up losing a lot of money by buying on margin.

The Bottom Line

There are various kinds of debts that can come under good debts and bad debts. While some of these make it easier for you to achieve your goals, there are others that make it all the more difficult for you to accomplish them. This is why you need to be very cautions while borrowing money. You have to be able to identify your good debts from the bad ones and make sure you understand the costs associated with them. The key lies in handling them well and having a plan on what to do when you are facing too much debt.