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Understanding Good Debt & Bad Debt And The Difference
Is all debt bad debt? This is one of the age-old questions that have been asked for generations. After all, owing money to a bank or financial institution can’t be a good thing, can it? Isn’t it bad to be in debt in the first place? After all, we have all heard the saying, “All debt is bad debt”.
However, the truth is far more nuanced than this. Now is a better time than any to understand debt – both good and bad.
Debt can be good if it helps you grow your finances in the long run without affecting your ability to pay back the principal amount with interest. However, one needs to take excessive care and precautions when it comes to taking out debt – because it can either lead you to become extremely successful or drive you down a path of bankruptcy.
With this in mind, we take a look at the differences between good and bad debt, and some examples of each to shed light on the topic beyond doubt. First, good debt.
Good Debt
To keep it simple, good debt leaves you better off than before you borrowed the amount. It often leads you down a path of prosperity and growth. There are many purposes one might take out debt that could eventually turn out to be positive for the borrower. For better clarity, let’s look at some examples of good debt –
Bad Debt
Bad debt can ruin one’s financial position and leave one struggling to pay it off. The main reason for this is that it doesn’t help you generate more income. Here are some examples of bad debt –
How Does One Know If Debt Is Good Or Bad?
In short, good debt has the potential to earn you significant returns over the long term. For example, taking out debt to start a business which later goes on to be successful can be considered to be good debt. The reason being, taking out the debt has brought you to a much better financial standing than you were in before.
Bad debt is often taken out to fund depreciating liabilities, that don’t earn you any income. These are often harder to pay back and do not leave you in a better financial position than you once were.
So as it is clear, the difference between good debt and bad debt is the financial position it puts the borrower in. Loans taken out for consumables that depreciate over time are often bad debt. Debt taken out to produce income and add value to the economy is often considered to be good debt.