What is the Difference between Good and Bad Debt?

If you have ever done research or read books on personal finance, chances are you have heard of the terms good debt and bad debt come up. One of the big questions you may have is, “What is the difference? Debt is debt right?” While there are various definitions and depending on whom you ask (i.e. a banker vs. a financial planner) you will likely get a different response. Below is a neutral explanation on the differences between the debts.

What is the Difference between Good and Bad Debt?

In its simplest form, good debt can be considered any debt taken on that will result in an increase of assets for a person. For instance, good debt can be considered debt that is used to purchase a home that will likely increase in value over the years, or to purchase a college education which will provide a good return on investment over the course of one’s life. Essentially good debt is any type of borrowed money that has the ability to increase in value or provide some type of return.
Bad debt on the other hand includes everything else. Credit card purchases for clothes, entertainment, or partying would all be considered bad debt. Other forms of bad debt include using a line of credit to go on an extravagant vacation. Just remember, if the debt results in an increase in one’s assets, it is good, if not, it is considered bad.

 
The Benefits of Knowing Good Debt from Bad Debt

There are numerous benefits in understanding the benefits and pitfalls of good vs. bad debt. Being financial wiser will enable you to make sound financial decisions that will improve your life drastically – especially when one enters their retirement years.

If you spend your life acquiring assets through good debts that are paid off before retirement you will be in a strong financial position to enjoy retirement. However, poor debt management can result in a very stressful retirement whereby you will have to continue to work or drastically change your lifestyle.

Knowing the difference between good and bad debt is only the start. Establishing good spending habits and putting these practices in place is important for positive financial management. Next time you are debating on a general high ticket purchase, ask yourself what are the true benefits of this item and is this a good use of debt.

The primary message you should take away from this article is that good debt is debt that increases your assets without straining you financially whereas bad debt is any debt you take on that does not increase your assets. Not only does increasing your financial intelligence go a long way in ensuring financial freedom when you enter retirement, it will also give you the peace of mind now knowing that you are doing what is needed to have a bright financial future. Another great source of information on finances is the Fox Symes Blog, there is a wealth of information specific to debt there.