09/ 14/ 2007
by Glenn Townes
Financial empowerment and small-business success start with knowing the difference between good debt and bad debt. Surprisingly, not all debt is bad—contrary to the popular notion that it’s indeed better to be debt-free. Debt can build credit and help secure assets, but it can also wreck your credit and drain your pocketbook.
Here’s a detailed breakdown of what is considered good debt by some:
Good debt is generally anything that appreciates in value over time. The rule also applies to anything that has the potential to increase over the long-term. Just because something has the word “loan” attached to it doesn't mean that the loan is automatically a bad or negative thing.
Some examples of good debt include:
- Student loans. These are considered good debt because educational loans can help you earn more money during your lifetime. According to various national studies and reports, a person with a master’s degree will earn, on average, $1.3 million more during his lifetime than a person with a high-school diploma.
- Business loans. These are also considered good debt because they can be used to expand an already established small business. You can use resources obtained through business loans to increase profitability and expand services or products. In addition, business loans can be an asset to every entrepreneur who wisely uses the funds strictly for the business.
- Home mortgages. These are assets that increase significantly over time. For example, a home purchased today near a major Northeast city for $300,000 has the potential to double or perhaps triple in value throughout the course of 20 to 30 years. Also, mortgage interest payments and other costs associated with maintaining homes are often tax deductible. In addition, the equity in a home can be parlayed into a business loan to enhance your small business.
Bad debt is generally anything that decreases in value immediately after you purchase it. Bad debt is a liability that usually has a high and, in some cases, a usurious interest rate.
Some examples of bad debt are:
- Automobile loans. The value of the car depreciates the moment you drive it off the lot. It’s a much wiser investment to purchase transportation that’s practical and inexpensive rather than something flashy and overpriced.
- Credit/charge cards. Charge cards with interest rates of 13.5 percent or higher are the worst kind of bad debt, according to some experts. For example, if you purchase $50 worth of groceries or supplies with a credit card with a 17 or 18 percent interest rate and make the minimum monthly payment, the debt used to make the purchase will ultimately be paid off in 12 years.
- Payday loans. These are short-term, high-interest cash loans designed to help consumers with less-than-perfect credit. The loans usually have a triple-digit interest rate and generally have a repayment time frame of two weeks. The loans can be extended as many times as the borrower requests, with a finance charge being assessed each time and nothing being applied to the principal balance of the loan. In most cases, the borrower ends up repaying as much as triple the amount of the original loan.
Finally, it is essential to remember that ultimately, any debt—including good debt—can lead to a financial breakdown or even disaster. Keep in mind that just because something is considered a good debt does not mean that you should take on more than you can handle. Whether debt falls into the good or bad category, the key to building wealth and financial security as both a consumer and an entrepreneur is to never allow debt to outweigh income and assets.
