by Kate Flaxx

Created on: November 19, 2010

Debt is a scary word for the majority of people and when it comes to debt or owing money for whatever reason, there is a misconception that having debt is always a bad thing.  It’s true that debt can affect your life in a negative way bringing with it stress and sleepless nights, but before you start tossing and turning at night, ask yourself this question ‘Is my debt good or bad’.  To differentiate the difference and to effectively answer your own questions, refer to the explanations below;

• What is good debt?

Good debt involves the purchase of something that’s going to be worth more in the future.  That is, something you buy that’s going to appreciate or rise in value.  For example, one of the main debts described as a good debt is the purchase of a home.  This is seen as a good debt because when making payments to a home loan, you are paying off an asset that is going to be worth more in the future.  This means you will end up gaining more money than what you originally paid for the house so this is why a home loan is described as a good debt.

• What is bad debt?

Bad debt is purchasing items or paying out money for something that is not going to rise in value in the future. Using a credit card to pay for clothing or everyday food items for example can be seen as bad debt.  Taking out a personal loan for the purpose of taking a relaxing holiday is also a good example of a bad debt.  The clothing, the food and the holiday is consumable.  The clothing will get worn, the food will be eaten and the holiday will be taken.  These things will not be around in the future to give any financial return and because they are paid by credit card or personal loan, they are giving you a debt where you receive no return when the personal loan or credit card is paid off.

•How do you tell the difference between good and bad debt?

When identifying the difference between good and bad debt try asking yourself the question; ‘If I borrow this money now, will I receive a financial return when I pay this debt?’   Similarly if you use a credit card often, ask yourself; ‘If I buy this item now, will it appreciate in value, and will I gain a return in the future?’

In summary;

A home loan is a good debt; it gives you an asset you can sell for more than the original worth. Purchase of $500.00 for new clothing using a credit card is a bad debt; these items will decrease in value and have no financial return.  You will probably still be paying for these items by the time they wear out.

Taking out a personal loan to invest is a good debt; this gives you a financial return but depends on your investment strategy and what you invest in but there is a possibility for a return at the end of the loan term. Taking a personal loan for relaxing holiday is bad debt; even if you know you deserve a holiday this will give you no return. You will still be paying for the holiday when you come home.  In paying back the loan you will still be paying for something that has already been used and does not assist you in any way in the future.

Next time you examine your debt, have a go at deciding if it's good or bad.  You may be pleasantly surprised.

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