Good Debt vs Bad Debt: Where Does Most of Your Money Fall?
While using cash is preferable to going into debt, the truth of the matter is that a zero-debt existence is all but impossible for most people. According to the Federal Reserve’s G.19 report on consumer credit, the total U.S. outstanding debt was $3.076 trillion as of October 2013. The 2012 Consumer Financial Literacy Survey found that nearly two out of every five Americans carried credit card debt from month to month as of March 2012. Although debt should be avoided whenever possible, there are times when people may have few other choices. This article will look at the differences between good debt and bad debt so that people can quickly figure out which of the two categories most of their money falls into.
Good Debt: Vehicles and Homes
Having a good, reliable car could be necessary for many people, so entering into financing arrangements might be in order if a cash purchase is unrealistic. Before signing on the dotted line, however, people need to compare the true cost of the vehicle in terms of total price and monthly payments with what they can realistically afford to pay. This is the only way for people to gauge if they can truly afford a particular vehicle. As is the case with all situations that involve taking on debt, the key is to pay up front as much of the total cost as possible, without draining any emergency funds accounts, before financing the balance. Another case where debt can fall into the good category involves the purchase of a new home. Most people won’t be able to buy a home outright with cash, so proper planning is in order. Generally speaking, people who can afford to table a down payment of at least 20% of the value of the house will have access to the most favorable mortgage deals. Moreover, they’ll have a lower balance to pay off than would someone buying a similarly-priced home with a much smaller down payment.
Bad Debt: Impulse Buys and Credit Cards
There are many examples of bad debt. People who shoulder debt to buy things that neither generate income over the long term nor hold onto their value for very long can be certain that they’ve entered the bad debt category. Another characteristic of bad debt is that it comes with a substantial interest rate, which is the case with credit cards. For instance, people who use credit cards to buy, say, a $300 jacket, but who don’t have the financial wherewithal to pay off the amount before interest is assessed, will eventually see the amount climb from $300 to $350, from $350 to $400, and so on as interest quickly increases the total money owed. The general rule of thumb is that people should avoid buying anything they can’t afford if they don’t truly need it.
Zero debt is the ideal, but the perfect scenario isn’t realistic for most people at certain points in their life. It’s a process to get there. As a result, people need to understand the difference between good debt and bad debt so they can determine where most of their money falls and take whatever corrective actions may be necessary.
With hard work, and some good advice about debt, you can be out of debt before you know it.