“Good debt is a powerful tool. But bad debt can kill you.” – Robert Kiyosaki
For a lot of people today, debt is nothing more than an unavoidable part of life. It could even be how you pay for just about everything from the home you might be living in, to the car you drive and even down to the small, day to day purchases like food, gas and that daily cup of coffee (or 3). It’s become so accepted in society that you probably don’t even think twice about the consequences.
No matter how debt is used or what it is used for…simply put, debt is an amount of money borrowed by one party from another that needs to be paid back. Based on that explanation, debt may not sound good or bad. As a matter of fact, no matter how you view it, all debt needs to be paid back…period! It is how it gets paid back that makes the difference.
The Fine Line Between Good Debt and Bad Debt
What you need to understand is that there are two different types of debt and that not all debt is considered equal. The reality is that there is a difference between good debt and bad debt. Although there is some debate about what those differences are, the easiest way to think about it is…good debt puts money in your “pocket”, where bad debt takes money out of your “pocket”!
There are many instances where there is a fine line between the two. And the reason it is a fine line is because debt that’s used to purchase an investment can shift from being an asset by the investment paying back the debt, to being a liability by you having to pay back the debt. To realize and understand that difference is so important in your journey to financial freedom.
“Bad debt is sacrificing your future day needs for your present day desires.” – Suze Orman
You may have heard that not all debt is the same and there’s a misconception about what you might consider good debt, when in reality it may be bad! Bad debt is usually obvious and sometimes it’s not. So, what is bad debt? Let’s break it down…bad debt is money you borrow to pay for something that will not increase in value and/or not pay you back after you make the purchase.
A prime example is using a credit card to pay for that round of drinks just to impress friends. Another example would be a car loan. Vehicles lose more than 50% of their value within the first five years. Even taking out a mortgage to buy a primary residence can be considered bad debt! Until you’ve completely paid off the mortgage and sell the house for more than you paid for it, it’s bad debt.
Even after the mortgage is paid, there is always maintenance, up keep and property taxes…money coming out of your pocket, right? Although the price of real estate historically goes up (if you hold on to it long enough), hopefully you can sell it for more than you paid for it, including all the money spent during the years for maintenance, up keep and property taxes.
Now, I’m not saying don’t ever buy a house, but for the sake of understanding the difference between good debt and bad debt and the fine line between them, this is definitely food for thought. Understanding the basic principle for what bad debt really is will help you to recognize that good debt isn’t always what it seems. It’s with that understanding that you can properly assess your financial well-being.
“Not all debt is bad. From time to time we should get into debt when there’s a good reason for that.” – Dan Ariely
There really are two sides to debt. In general debt is typically bad, but on the flip side, there is good debt. So, what is good debt? Good debt is money you borrow to pay for something that will increase in value and/or will pay you back after you make the purchase. An example of debt that’s good would be debt that pays for furthering your education, provided that the education produces income.
Another example, such as financing an investment property, is usually considered good debt as long as the rent payments are greater than all the expenses incurred and it can be sold for more than the purchase price. As I hope you’re beginning to realize just from these couple of examples, is that debt is not always bad in certain circumstances if managed properly.
Even financing a car can be considered good debt if its use will generate income greater than the expenses, as in a taxi or shuttle service. On that same note, borrowing money to start a business can also be considered good debt, providing the business at some point generates income to re-pay the debt.
As you can see, there is a difference between good debt and bad debt. Hopefully you understand the fine line that is between them in certain circumstances. The thing with good debt is that it has the potential at any point of becoming bad debt. But don’t be discouraged, because it’s that understanding that will improve your financial well-being and get you on the road to creating wealth.
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