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Multitasking Money Part 4 (a) - Is Debt Good or Bad?

Updated: Mar 28, 2023

Good Debt vs. Bad Debt?

Part 1: Bad Debt

Alan J. Mendlowitz, RICP, CRES

"Bad debt is a crushing weight that drags down not just the individual but the whole economy." -President Barack Obama


Introduction

The word “debt” is a loaded term. It triggers feelings of fear, anxiety, and guilt in most people. Debt can seem like an inevitable downfall that leads to bankruptcy and financial ruin. But the truth is, some debt helps us build our futures while other types are just detrimental to our lives. There are many types of debt and some of them can be good for you. If you have the right type of loan, it can help you purchase a tangible asset that could appreciate in value over time. Debt also has its place when investing in your own education or starting a business as it allows people to take risks without risking all their money up front. However, there is one type of debt that should be avoided at all costs: bad debt. Bad debt is any kind of borrowing that goes toward purchasing an asset with no intrinsic value such as entertainment, vacation trips, jewelry and clothing purchases etc., which means it doesn’t have the potential to go up in value like real estate or stocks after you purchase them.

The problem with bad debt is that it can quickly spiral out of control. Monthly payments on depreciating assets can quickly become more than the original purchase price, and before you know it, you’re in over your head. Doing this can often ‘kill’ your credit score for a really long time and have a ripple effect on many other things. {Check out a future blog on credit scores!}

One thing you may notice is that bad debt is easy to get while good debt can require a long arduous underwriting approval process. Which makes me think of something my kids like to say: “why can’t sugar candy be healthful and vegetables not?” Good things can be hard to get, and bad things can be addictive! If you avoid bad debt altogether, you’ll be in a good financial position down the road. If you can use good debt to your advantage, you’ll be in an even better financial position down the road!

Bad Debt

Credit Cards

Using a credit card to purchase clothing, entertainment, or vacations when you do not have the money to pay that bill at the end of the month can be a sign of bad debt. When you use plastic to pay for these items, you're typically borrowing money at a high interest rate. This can quickly add up if you don't have the money to pay off your balance in full each month.

If you're struggling to pay your credit card bills, it's best to avoid using your card for discretionary purchases. Instead, try to save up for what you want and use cash or a debit card to make your purchases. This will help you stay out of debt and keep your finances in check.

Things that can be bad debt:

When you borrow money to purchase a car, you could be taking on bad debt. Cars are a depreciating asset, which means they lose value as soon as you drive them off the lot. The value of a new car drops by about 20% as soon as it's driven away, and it continues to decline from there. While a car is a necessity for many who need to get around (not just to live life but to get to work!) borrowing money to pay for a car you cannot truly afford is bad debt.

When it comes to student loans, there's no one-size-fits-all answer. Some students may benefit in the long run by taking out loans for a degree. For example, if you end up in a field with high earning potential or with a job that merits student loan relief. It all depends on the individual's circumstances and goals. If you're interested in becoming a doctor, it can be a good idea to take out student loans. Doctors are typically well-paid, and the investment in a medical education is likely to pay off in the long run. However, other professions may not pay enough when you start out and enable you to afford to pay the student loans. The important thing to remember is that student loans should only be taken out as a last resort. Before you borrow money to pay for school, make sure you've explored all of your other options. There are many scholarships and grants available to students, so don't be afraid to ask around for help. (Ask me for more info or check out my future blogs about how to pay less for college rather than how to save more!)

Conclusion

It can be tempting to take on bad debt when buying a car, using credit cards for discretionary purchases or taking out student loans. However, borrowing money from the bank is not without risk as it may lead you into deep financial trouble if used improperly. The key to avoiding this situation altogether is to pay attention and use discretion when spending borrowed money. If you need more information about how to borrow responsibly and create an effective budget plan that includes all your income sources and expenses, feel free reach out! We're here with advice at every step of the way.

Don’t forget to check out Part 2 of the Good Debt – Bad Debt Blog as part of the Multitasking Money Blog Series.



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