The difference between good and bad debt

Despite what you may have heard not all debt is bad, there are actually times when borrowing money is a good idea. The trick is being able to tell the difference between good debt and bad debt. There are times when this can be a challenge since it is often not clear. On the other hand most debt that people rack up is very decidedly bad debt.

The main difference between good debt and bad debt is that good debt is debt that is used to pay for something that will increase in value. The reason that this is considered to be good debt is that it will allow you to increase your wealth since the money was used for something that will hopefully be worth more in the future. The classic example of this would be the mortgage on your house. Since the value of the house is likely going to increase you will actually make more money from the appreciation of the house than the cost of the interest on the money that you borrowed.

There are all kinds of other examples of good debt, borrowing money to invest in your retirement fund, to start a business or to renovate your house are all good examples. Even student loans can be considered to be good debt since they are being used to help you to improve your skills so that you will be able to get a better job in the future. All of these are examples where the money that is being borrowed is being used for something that will increase in value by enough to offset the cost of the interest that came from borrowing the money.

Bad debt is obviously the opposite of good debt; it is when you are borrowing money to pay for things that are not going to increase in value. Most consumer products will fall into this category, in most cases as soon as you take them out of the package the value will decrease. The worst example of bad debt is when you borrow money to pay for consumables; it is never a good idea to use a credit card to pay for food example.

Being able to tell the difference between good debt and bad debt can be tricky at times, there is a lot of grey area. An example of this would be borrowing money to buy a car. In almost all cases the value of the car will decrease very rapidly so it would not be considered good debt. However if the cost of driving the car also declines with the new car then it may actually be a good idea to borrow the money. The question that you have to ask yourself is whether the whatever you are borrowing the money for will either make you money or reduce your expenses. If the answer is no then it is bad debt.