Good Debt vs Bad Debt

good-debt-bad-debtBorrowing is bad, right? As a rule of thumb, one should always try to pay cash when you can.

However, there are instances (sometime with major purchases) you may not have that kind of cash on hand.  There is such a thing as good debt and bad debt- and it would behoove all budget-friendly types to know the difference.

Should I Borrow Money?

What are you using it for? Are you investing in your home? Buying a car? Going on Vacation? Getting a makeover?

A good rule of thumb is: is your intended purchase/spending going to appreciate in value?

If it is a simple yes- than there is a decent case to borrow money. Good debt includes, mortgage loans as well as borrowing to do home renovations. Most renovations will increase the asset value of your home, although certainly some do add more value than others (bathrooms and kitchens are the most expensive to do, but will yield the biggest results).

It’s considered “good debt” to borrow money for your education. In theory, the more knowledge and skills you gather, the greater your earning potential down the road.

Grey Areas-

One of those tough ones is- should I borrow money to buy a car? While you are securing your loan with an asset- the car- cars depreciate with value over time, some of them significantly and swiftly.

Truthfully, most people do borrow to buy a car- and include car payments as part of their monthly spending.

One way to mitigate the risks (and potential extra costs) is to try and borrow less. Consider saving up for a decent down payment. This will have you borrow less. If you ran into financial distress and needed to sell the car, you would owe less than the car is worth.

Consider buying used as well. Even a car that is one year old will give you much of the benefits of a new car, but at a seriously smaller price.

Bad Debt

Borrowing for non-essential (although nice-to-have) items, like clothing, electronics, vacations etc. falls squarely under the “bad debt” category.

A far better idea is to save up, or to allocate spending towards these items within your monthly budget and pay cash.