Do you know that when a lender looks at your credit report to see what kinds of debts you have, they’ll look at some debts more favorably than others? In as much as you’re fighting your way out of debts so you can be debt-free, it’s important to note that not all debts are bad.
If you’re struggling with multiple debts, you first need to understand which debts are considered as good and bad debt. That way, you can prioritize your debts so that you get rid of the bad ones first.
Good Debt
Some of your debts might be considered an investment. This is especially true if you took on the debts to purchase something that will increase in value and can contribute to your overall financial health.
For instance, a home purchase can be considered to be a good debt. Since homes usually appreciate in value, the mortgage loan you take out to pay for the home is an investment. Another good example is a student loan taken out to finance a college education. Earning a college degree usually means that you’ll make more money in the future.
Bad Debt
When you use debts to finance things that can be consumed, you’re taking on bad debts. It is the kind of debt that creates an unhealthy financial situation. Credit card debt is often considered bad because of the nature of items that credit cards are used to purchase. You should never use debts to purchase everyday items like clothes or food. If you use a credit card for these types of purchases, it should be intentional, e.g., for better financial management or to earn rewards. You should pay the balance in full each month.
Even debt used to finance a vacation is bad debt. Although it might help you feel better and be more productive once you return, a vacation does not appreciate in value. Don’t use debts to pay for a vacation and especially don’t use them to pay for a vacation you can’t afford.
Making Good Financial Choices
Good debt is obtained by making wise decisions about your future, not for the sole purpose of having good debts. For example, you might make the decision to obtain your Master’s degree to increase your earning potential. Taking out a student loan, if you have no other way of financing your education, is a valid reason for taking on additional debt.
It’s usually a good idea to focus on paying off your bad debts first. Since they provide no value, they’re more costly than your good debts. You should pay off credit cards and auto loans before tackling mortgages or student loans.
Some people consider using good debts to pay off bad debts. This is not a good idea for several reasons. First, repaying debts with debt is never a good idea. Second, it ends up taking longer to pay off the mortgage than it would have otherwise.
Third, the higher mortgage increases your monthly payments, and the time it takes to build equity in your home. Use cash to repay debts, not the other way round.
You must still be careful that you don’t take on too many debts, even if it’s good. If you’re overloaded with debts, then it doesn’t matter whether it is good or bad, it still hurts your financial health.
