What’s the purpose of getting a loan? In most cases, borrowing money is done in order to pay for something you want or need, such as a college education. But what considers as a good debt vs bad debt?
Four-year college degrees can easily cost $100,000, $150,000, $200,000, or even $250,000, depending on the school.
Having that type of money on hand is out of the question for the vast majority of people. In other words, you can afford the school if you take out a loan to cover a portion of the expense.
What about a brand-new vehicle? Visit your local dealership and you’ll be charged at least $25,000 for a new automobile.
It’s true that more individuals can afford this than a college education, but what if you don’t? Is it a good idea to fund your car the same way you do your education?
Money is spent when you spend $1,500 on a vacation. Poof! Even if you have fond memories and pictures to show for it, you have nothing of monetary worth to show for it.
To be clear, this does not mean you should avoid taking a vacation.
Depending on your budget, you can take as few or as many trips as you want each year.
In any case, you should just take what you can. You can’t afford to go on vacation if you have to take out a loan in the shape of a long-term credit card debt.
Related Article: How To Get Out Of Debt On Your Own
👀 Good Debt vs Bad Debt: The Definitive Guide
🧐 What Is Bad Debt?
Bad debt is quite easy to spot.
It’s bad debt if the item u bought loses its value the moment you acquire it.
Sadly, this is true of many of our wants such as clothing, sports cars, and that high-resolution wide-screen TV.
If you’re strapped on funds, you might want to look into buying off-brand clothing, a gently used car, or a 54-inch flat-screen television.
1. Credit Cards
Interest rates in credit cards are a silent killer of your financial well-being.
Credit card companies don’t care if you can’t figure out how to use it.
If you will be required to pay $60 a month, it would take about 63 months and cost $1,676.98 to pay off (which is more than the minimum necessary). There is a price to pay for a high-definition version of Trevor Lawrence.
Over the next five years, the percentage of Americans who maintain a revolving credit card balance will climb from 37% to 43% of all Americans.
Using up greater than 30% of your available credit will hurt your credit score.
2. Payday Loans
A payday loan is ten to fifteen times worse than a credit card loan. You obtain short-term financing to help you get through a problem. In exchange, you post-date a check in the hope of repaying the debt when the next salary arrives.
It might be convenient and quick, but loan rates range between $15 and $30 per $100 borrowed. A standard 2-week payday loan of $15 per $100 corresponds to a 400 percent annual rate.
3. Automobile Loans
Unless it’s a rare collectible, the value of a car drops by 20% in the first half-mile after it leaves the lot, making car financing a lousy investment.
There are a few advantages and disadvantages to owning a car, including the fact that financing rates on automobiles are quite cheap.
In terms of money, it’s best not to buy a Mercedes Benz when a cheaper model will suffice. Make sure you pay off this loan on time if you want to one day acquire a better model.
😇 What Is Good Debt?
Having a healthy amount of debt enables you to better manage your money, take advantage of your assets, make purchases, and deal with unanticipated circumstances.
There are many forms of good debt, such as getting a mortgage loan, or investing in your education, or consolidating debt.
You may find yourself in a financial hole at first, but in the long run, you’ll be better off for having borrowed that amount of money rather than pulling it out of your own pocket.
1. Taking out a Mortgage
For starters, you’ll need a place to call home. You can consider living in an area that appreciates in value on a regular basis.
A burst in the real estate bubble happened way back in 2008, which made us rethink homeownership as a source of wealth for a short period of time.
However, since the gloomy depths of the 2010 Great Recession, consider what has occurred: House prices have risen by a whopping 27.25 percent over the past year.
According to Federal Housing Finance Agency, property prices rose by 10.8% in 2020 alone, despite our nationwide coronavirus lockdown.
What does it all add out to in terms of dollars and cents?
If you purchase a $235,000 house that has an appreciation at about a 3% annual rate, the property will amount to $485,000 when your 30-year mortgage is paid off — more than twice what you paid for it. Your initial $235,000 investment is going to be worth $649,000 in three years if it grows at a four percent annual rate of return on the original capital investment.
That’s a high-quality loan.
Related Article: Renting vs. Buying A Home: A Complete Guide
2. Acquiring Home Equity Loan
A mortgage’s close relatives include home equity loans.
Borrowers can get a low-interest loan by pledging their home’s equity, which is the difference between the current value of the property and the outstanding mortgage balance.
In order to pay the high-interest obligations, such as credit card loans, many people use home equity loans. Adding solar panels, for example, can save electricity costs while also increasing the monetary worth of a home.
You could lose your house if you don’t keep up with the payments, so this isn’t a risk-free strategy.
3. Student Loan
There has been tremendous growth in the student loan market.
Student loan debt, at $1.6 trillion, is the second-largest source of consumer debt in the United States, after mortgages. Credit card debt exceeds student loan debt by more than two to one.
Students may also be losing faith in the value of taking on debt to further their education.
Many Millennials who took out student loans say they regret it, according to a recent CNBC survey.
Well, investing in an education that may lead to a lucrative profession is certainly worth it, but only if you can be certain of the outcome.
According to a 2020 PayScale analysis, mothers should let their children grow up to become petroleum engineers, computer scientists or electrical engineers, operations specialists, or metallurgical engineers.
📌 Bottom Line
In this article, we have nailed down the difference between good debt vs bad debt. Ask yourself how this purchase will help you in the long run, not simply in the immediate future. Is the money you’ll borrow going to help you in the long run, or is it just to satisfy a short-term craving that you can’t afford?
A rainy-day fund or emergency fund can help you avoid using your credit cards to pay for unforeseen bills.
Try to keep your ratio of debt to accessible credit (the ratio of your overall debt to the total credit you have) at a minimum to avoid being seen as a dangerous borrower by lenders.
Prioritize debt repayment and avoid making any additional purchases.
Finally, don’t forget to always pay your bills on time, whether it be good debt vs bad debt.
❓You Might Ask
1. What is good debt vs bad debt?
It’s possible that good debt might boost your net worth or improve your quality of life. Borrowing to buy fast depreciating assets or simply to consume is a form of bad debt.
2. Good Debt vs Bad Debt: What is meant by bad debt?
“Bad debt” refers to loans or unpaid amounts that are no longer collectible and must be written off. These types of expenses are incurred when clients are extended credit, as there is always a danger of default.
