September 1, 2016

Good Debt vs. Bad Debt

By Jennifer Clark

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By definition, debt is simply an amount of money borrowed by one party from another. And for most of us, debt is a necessary part of life. We borrow money so that we can buy goods or services that we otherwise could not afford right away.

In this sense, all debt is the same: we take now and give back in the future. But because debt can have positive or negative consequences, it’s typically thought of as good debt or bad debt.

To help you make the distinction, it’s important to be able to differentiate between wants and needs, by identifying your fixed expenses, variable expenses, and discretionary spending. 

Good Debt

Technical of College Education: Many studies show a positive correlation between education and the ability to find employment opportunities. Better educated workers are more likely to be employed in good-paying jobs, and tend to have an easier time finding new opportunities. An investment in a technical or college degree is likely to pay for itself.

Paying for Medical Care: If you need to borrow money for a treatment or surgery, do it. Health always comes first.

Small Business Ownership: Being in business for yourself is not only empowering but often times it can be lucrative. Some of the largest brands and businesses of today including Facebook, Google, and Coca-Cola, all had humble beginnings.

Real Estate: According to a Bankrate survey, more than 1 in 4 Americans said real estate is the best investment, and financial experts, like Laura Adams Buying a home and living in it for a few decades before selling it at a profit is one way, but residential real estate can also be used to generate income, by renting the property. Commercial real estate can also be an excellent source of cash flow and capital gains for investors.

Bad Debt

Credit Cards: The high interest-rate credit cards can end up wreaking havoc on your financial future. In order to keep interest rates to a minimum, pay off your total balance at the end of each month.

Borrowing from a 401(k) or Retirement Plan: Not only will you incur penalty fees for early withdrawal, but borrowing from your 401(k) or retirement plan, can significantly sidetrack your savings plan. Borrowers may potentially miss out on any compound growth that their investment would otherwise have earned in the market.

Payday loans: When cash is tight, some people turn to pay day or similar short-term high interest loans to make ends meet. The CFPB defines a payday loan as short-term loan, generally for $500 or less, that is typically due on your next payday. While these loans offer quick access to money, they often carry an average annual interest rate of over 300%, that’s according to a new survey by the CFPB.

Purchasing a Car. If you’re financing a car, financial guru Suze Orman suggests a three-year loan – no longer.  She also says that leasing doesn’t make sense because it keeps you perpetually in bad debt.

Luxury Items like Jewelry and Expensive Clothes: While we all need food, shelter and clothing, we definitely don’t need a Chanel bag. If you cannot comfortably afford to pay for luxury items like expensive clothes and jewelry, don’t do it.

Making Good Choices About Debt

Remember, your financial future and well-being rely heavily on the financial decisions that you make now. In order to learn more about financial wellness, please check out Prosper’s latest guide, Dollars & $ense, a guide to financial literacy and wellness.