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Written by: Kevin Gardner
There is a common misconception that all debt is bad. In reality, there are several types of debt that, when used wisely, can be good. In many cases, these debts serve as solid investments in your future.
If you are wondering how to tell the difference between good and bad debt, stop for a moment and think about the purpose of your borrowing. If it is for something you want or that will depreciate rapidly, it's usually better to save up before making a purchase or skip it altogether. On the other hand, if you need to make the purchase, say for medical treatment, then it makes sense to move forward while borrowing.
Another clue is to look at the interest rate and structure. In cases where you can borrow for very low interest rates, it might be a good investment. This is especially true if your savings are earning a decent return where they are invested. On the other hand, higher rates can make it virtually impossible to pay off some debts.
Keeping these factors in mind as a guide, take a few minutes to consider these four types of good debt that can help you achieve a more stable financial future.
1. Education Loans
Many of the most promising careers require at least some level of post-secondary education. That could be training at a technical school or an advanced university degree depending on the field you are planning to enter. Either way, that education will cost you.
Student loans make it possible for students without college funds to attend school, get training and secure stable employment. In this way, they are a valuable tool for a better future. Many education loans also offer competitive interest rates, making them even more attractive.
2. Home Mortgage
This is another great tool that is generally considered good debt. Mortgages often have very attractive interest rates, especially for borrowers that have good credit and a sizeable down payment. They also afford housing stability and the opportunity to invest in real estate, which has historically offered solid returns on the initial investment.
Homebuyers should practice responsible borrowing when it comes to mortgages. Poor borrowing choices and questionable lending practices played significant roles in the 2008 housing crisis. You can avoid turning a mortgage into bad debt by staying within recommended debt to income limits and purchasing only as much home as you can genuinely afford.
3. Credit Builder Loans
Borrowing is very expensive if you do not have good credit. Unfortunately, high interest rates make it hard to make payments on time and build a better credit profile. Credit builder loans are designed to offer a way to safely build credit while also helping you to build savings.
Use caution here because not all credit builder loans are good debt. Some can leave you overwhelmed and even more burdened than when you started. However, there are plenty of reliable lenders who are looking to help you find a clean start. It is usually a good idea to start by researching programs and choosing one designed for your specific situation.
4. Auto Loans
Taking out a car loan is generally considered to be good debt. That is, as long as you are not buying a more expensive car than you need or can afford. For example, if your current vehicle runs fine but you want one with a flashier appearance, then a car loan is probably not a good debt to take on. However, if you need a reliable car to get back and forth to work, then financing a vehicle makes more sense.
Conclusion
Contrary to popular belief, not all debt is bad. Opening a mortgage, auto loan, education loan or credit building account can be responsible ways to take on good debt that builds a more stable future.