Personal Finance Advice

You may have heard the terms good debt and bad debt and may have wondered exactly what they mean.  Isn’t all debt bad by definition because it obligates future income? Shouldn’t we try to avoid all debt at all costs?

The terms good and bad debt don’t really insinuate that one type of debt is great while one is lousy.  Most financial experts agree that a debt-free personal financial situation should be the ultimate goal of most consumers.  On the other hand, there are some instances where taking on debt may actually work to your benefit in the long run, and this is when it is considered good instead of bad.

For example, you have probably heard that a mortgage is considered to be good debt.  That’s not just because it puts a roof over your head, but also for a couple of other reasons:

1.  The home is usually expected to appreciate in value.

2.  The interest you pay on the mortgage loan is oftentimes tax deductible.

So even though a borrower winds up paying quite a bit of money in interest on a mortgage loan, the debt is still considered to be good debt. 

The same can be said for student loans.  Even though most people wind up paying their student loans off over a long period of time and also pay a great deal in interest, it’s still considered good debt because the return on the investment of education is supposed to pay off several times over.  In some cases, the interest paid is also tax deductible.

So what is bad debt? Debt is considered bad if it’s the result of a purchase that isn’t expected to appreciate in value.  Car loans are considered bad debt because cars almost always depreciate the second you drive them off the lot.  Credit card debt is also considered bad debt because all it does is sit and accumulate more interest that will eventually have to be paid off. 

The interesting thing about this, however, is that you can turn bad debt into good debt by consolidating it into an home equity loan or an equity line of credit, or by consolidating it with a cash-out mortgage refinance.  Use caution when using the equity in your home for consolidating bad debt.  You don’t want to lose your home to foreclosure from not paying an equity loan that consists mainly of credit card purchases.