Home Consumer debt What is the difference between good and bad debt?

What is the difference between good and bad debt?

0

Is it always negative to be in debt? Most people I talk to consider all debt bad – not just credit card debt caused by overspending, but also when it comes to personal loans, car loans, or mortgages.

Is there good debt? What is good debt and what is bad debt?

Good debt is often defined as money owed for something that can help build wealth or increase income over time, such as mortgages, student loans, or a business loan. These usually carry low interest rates.

Bad debt, on the other hand, refers to facilities such as credit cards or other consumer debt that do little to improve your financial situation. Some consider debt to buy depreciating assets like cars a bad debt. Credit card debt carries very high interest rates and is also considered a form of bad debt.

But is it as simple as a combination of interest rate and target?

What about your feelings about the debt and the emotional impact? Debt can be a very emotional topic. Like all financial decisions and situations, our mindset related to money will play an important role in what is considered good or bad for each individual.

How do you know what your debt mindset is? Think about how you feel about having debt. What do you think of the fact that others have debts? What language do you use when talking about debt, your own or someone else’s? Most will have strong feelings anyway.

When someone talks to me about their debt, the most common phrase I hear is: “I am in debt”.

The expression “drowning in debt” reinforces this idea that debt is exhausting and difficult to overcome.

Carol Glynn, Founder of Conscious Finance Coaching

That tells me a lot about their debt mindset. Framing your debt situation in this way implies that a person is physically in something negative.

The expression “drowning in debt” reinforces this idea that debt is exhausting and difficult to overcome. It insinuates that you are drowning or dying financially or worse, failing in life.

It is important to remember that debt is not physical and you cannot be part of it.

I prefer to say: “I have debts”. It is not part of the person, nor of their identity or their personal value. It is something we have to deal with and deal with that is separate from who we are and our physical being.

There’s another factor to consider when deciding whether debt is good or bad for your financial health: your debt-to-income ratio, which measures how much debt someone has in relation to their overall income.

It’s an important metric when reviewing your financial health or when deciding to take out a new loan or mortgage. If your total monthly debt payments are $2,000 and your income is $5,000, then your debt-to-income ratio is 0.4 (2,000:5,000).

Calculating your debt-to-income ratio will help you understand if you can afford to pay off your debts and tell you how much of your income is consumed by your debt. It is also an important factor in determining whether a mortgage provider will lend you.

It is important to calculate this number when deciding whether to apply for a personal loan, mortgage or car loan.

Credit card debt is part of this calculation, but remember that this is a real-life example of a bad debt.

It is always advisable to pay credit card bills as soon as possible, regardless of your debt ratio, because the effect of compound interest and high interest rates means that it multiplies very quickly.

Credit card debt is often caused by large unforeseen expenses or emergencies such as medical or dental bills, appliances that need to be replaced, or annual costs, such as car or medical insurance.

Setting up a “sink” fund and an emergency fund will help avoid having to use credit cards for emergencies or large annual expenses.

Debt is often fraught with shame, regret and anxiety. It is also the number one problem that people “go in the sand”.

If this is a major source of stress in your life, create a debt repayment plan and focus on eliminating this stress from your life. However, I also challenge you to think about the ideals that drive these feelings.

Are they yours or someone else’s? Perhaps you were brought up to believe that all credit is good and therefore rely on credit cards and loans for all major purchases.

But without understanding the impact, do you now find yourself with debt that you are struggling to maintain?

Or were you raised to believe that all debt is bad and therefore perhaps, even subconsciously, feel like you’re failing financially if you have a car loan, for example?

Remember, not all debt is bad and not all debt is good – but most importantly, having debt doesn’t make you a bad person or a financial failure.

Carol Glynn is the founder of Conscious Finance Coaching

Updated: April 01, 2022, 04:00