Today’s personal finance tip is about the concept of good debt and bad debt.
Financial gurus and websites these days often classify debt into two categories – good debt and bad debt – in order to prioritize debt repayment plans. However, this kind of labeling can be misleading because it encourages consumers to think certain types of debt are acceptable while others are not.
In reality, there is no such thing as a good debt.
If you enjoy reading quotes and proverbs about money and personal finance, you have probably come across the saying that equates debt to a modern form of slavery, and that applies to all kinds of debt.
Let’s dig a little deeper and see which type of debt falls under each label (i.e. good debt and bad debt). Long term debt that helps consumers build assets is considered good debt, and these include home loans as well as student loans. It is important to note that these assets help create more money, which can theoretically be used to repay the loan. Read more about good and bad debts at CNN Money.
On the opposite end of the spectrum are short term consumer loans that are acquired through credit cards or other lenders, and the money is used to buy consumable goods and services that do not appreciate in value like long term assets (such as real estate). Consumer loans are also often used to pay monthly bills or buy groceries, and so it is easy to see that this kind of short term debt does not lead to creation of money, which may be used to repay the loan itself.
Granted, one type of debt may lead to a better future compared to the other kind which simply puts a strain on your personal finances. However, the truth is, thousands of people face the prospects of bankruptcy because they have been unable to repay their home loans and student loans (i.e. good debt), and thousands more have already faced the harsh reality of losing their homes and other personal assets because of this ‘good debt’.
You can read about these worrying consequences of student loans in an article by The Huffington Post and another one TalkPoverty.org.
Perhaps, financial gurus can be more tactful in labeling asset-building long term debts as ‘less risky’ instead of ‘good’, and consumers can then fully understand the consequences of acquiring home loans and student loans.