The Different Kinds of Debt
Debt
There are few feelings that are worse than feeling underwater on your expenses.
Debt is a fact of life that virtually every American has experienced, and though not all debt is created equal, it always feels uncomfortable.
When discussing personal finances, the terms “good debt” and “bad debt” often come up to help categorize the types of ventures for which we should be taking out money.
How can we know good debt from bad debt? Are the principles the same regardless of the debt in question, or are they flexible terms?
Unless you are the happy recipient of institutional wealth that affords you to pay for everything in cash (and there’s nothing wrong with that if you are), you are not only likely to experience the feeling of taking out money for a major purchase but in many ways, society encourages a certain modicum of debt to get by.
Good Debt
The concept of “good debt” is, at its core, a description of taking out a loan for an appreciable entity﹘the type of belonging that has the potential to grow in value or create wealth, creating a positive dividend when accounts are settled.
While there are guidelines as to what constitutes good debt, living in a capitalist society that is so heavily influenced by the movements of the free market means that nothing is “financially bulletproof.”
As in all things, wisdom and prudence are crucial to ensuring the debt you’re undertaking is for an appreciable cause.
Acknowledging that there are very few guarantees in life (and even fewer where the money is concerned) there are areas where the debt required to enter can be seen as a good investment, rather than a foolish extravagance.
Buying a House
Taking out a mortgage to buy a home is likely the biggest loan an average person is obliged to apply for, and one of the safest.
Banks and credit unions are aware that virtually everyone will need a loan to pay for their first (or second) home, and so they offer a bunch of different types of mortgages to help people get the money they need. Such mortgages include:
- Adjustable-rate mortgages (ARMs): These mortgages’ monthly payments are subject to change based on the conditions of the housing market. Usually, these types of loans are locked into a specific interest rate for a certain amount of time but will readjust once that term is up.
- Fixed-rate mortgages: These types of loans opt for a more stable interest rate that is set according to the market strength at the time the loan is taken out. If the market eventually adjusts to a lower interest rate while you are still making payments you can apply to refinance your home and lock back in at the lower rate. You would just add on the outstanding time left on the loan to the new loan you take out.
While the appreciation of the home means that you are increasing your equity every time you make a monthly payment, mortgages aren’t always securely classed as “good debt.”
Since the Great Recession in 2008 people have learned just how important taking out a mortgage can be, especially if you borrow more money than you have the ability to repay.
Student Loans
Another type of debt that is generally considered a good investment is in yourself, your own education.
The adage that “to make money, you must first spend money,” has always been true, but that compounds when discussing education.
By empowering oneself with knowledge, increasing their hireability, and becoming an expert, a person’s earning power is going to eventually cover the cost of getting a higher education.
Initially going to college wasn’t meant to lead students into debt, or at least into the levels of debt that they currently experience.
Before the days of government grants and scholarships, colleges were more reasonably priced; then students started borrowing money to go to school and colleges knew they could raise their prices.
Consequently, that meant too that students would have to live with loan payments hanging over their heads, in some cases for decades.
One of the unfortunate facts about bankruptcy is that it can affect any person at any stage of life, whether they are educated or not.
Much like taking out a mortgage, a student loan can quickly go from “good debt” to “bad debt” based on the choices of the student and the hiring market.
While STEM degrees are generally more expensive, they offer more relevant skills that are in demand in this digital age.
Getting a degree in underwater basket weaving may not be enough to cover the cost of learning that skill.
Bad Debt
Bad debt is a much more common occurrence for most Americans.
Bad debt occurs when people invest in things that don’t have sufficient money-earning power, or that depreciate in value over time.
There are certainly ways for good debts to go sour, as has been mentioned above, but some things inherently take away from a person’s net value and offer very little in return.
Buying a New Car
In many ways, buying a new car is one of the easiest things to justify on this list.
Everyone needs mobility, and having a car can help a person get to work﹘or do their work, as construction workers and landscapers will assert﹘which means more money. That is all true.
But in very rare cases does the car itself add value to an individual’s bottom line.
It is much more lucrative to invest in a used car for less money, and not have to spend as much (or any) time paying back a credit union.
Credit Card Debt
One of the biggest culprits in perpetuating bad debt is unchecked credit card spending.
Credit cards are an incredible convenience, and many banks require a history of credit in order to qualify for a loan.
But they often come saddled with high interest rates that can quickly overtake a person if they are not paying more than the minimum payment per month.
Debt is a way of life for many people, but it doesn’t have to be a soul-crushing experience every time.
Taking out good loans and making good investments is as easy as keeping an ear to the ground and speaking with the experts.
Like using a credit card, there is a way to make the money work for you.
Share this:
Category: Debt
