Is Current Debt Good or Bad and How to Manage It

Debt is a double-edged sword - it can be a necessary evil for some, but a financial nightmare for others. In fact, according to a study, 77% of Americans have some form of debt, whether it's a mortgage, credit card balance, or student loan.

Having some debt can actually be beneficial, especially when it comes to financing big purchases like a home or a car. For instance, a mortgage can be a good debt because it allows you to own a home and potentially build equity over time.

However, not all debt is created equal, and high-interest debt like credit card balances can be a major financial burden. According to the article, credit card debt can have interest rates as high as 30% or more, making it difficult to pay off.

If this caught your attention, see: Bad Credit Mortgage Refin

Auto loans can be a good idea if you factor in the down payment, loan term, and interest rates into your budget. Working out these details can help you determine whether a car loan is a good idea.

A different take: Is a Debt Management Program a Good Idea

Home mortgage debt can be a good investment if you have good credit, as it can help you live in a nicer home and gain wealth from building equity. However, even mortgage debt is not risk-free, as the housing crisis of 2007-2009 showed us.

Credit cards can be a good option if you use them responsibly, as it can help you build credit and finance large purchases.

For your interest: Negative Equity Mortgage

Small business debt can be a viable way to help grow your business, as long as the debt burden is manageable. Borrowing to invest in a small business is generally considered "good debt" if it helps you make more money and build a successful business.

You should make sure that your debt burden is manageable, as there are still risks involved with borrowing for your small business. Many small business owners prefer to "bootstrap" their businesses with minimal debt.

Ideally, the debt should help position you to earn more money in the future. Borrowing money for higher education is similar, as it can help increase earnings.

It's essential to consider the risks involved with borrowing for your small business, just like you would with any other form of debt.

Worth a look: Borrowing from 401k to Pay off Credit Cards

Credit cards can be a useful tool for managing debt, but it's essential to use them responsibly. You can use credit cards to build credit, which can help you when you need to borrow money, finance a car, or rent an apartment.

With a rewards credit card, you can earn cash back or miles for everyday purchases, which can be a nice bonus. This can be especially helpful if you're already buying things you need anyway.

However, carrying a balance from month to month can lead to bad debt, as credit card debt can build up over time. High interest rates and fees can quickly add up, making it difficult to pay off your balance.

To avoid interest and fees, it's best to pay off your credit card balances in full each month, or as quickly as possible. This way, you can enjoy the benefits of using credit cards without getting into debt.

Suggestion: Do You Pay Debt Collectors

Debt can be a powerful tool for achieving financial freedom, but it's essential to understand the difference between good debt and bad debt. Good debt, also known as financial leverage, can help you amplify returns on an investment.

Financial leverage is when you use borrowed money to potentially amplify returns on an investment, as explained by Mook. This type of debt can be a part of your personal financial strategy if you employ it in moderation and use the right tactics.

Using financial leverage can increase your net rate of return, as seen in the example where investing $50 of your own money and borrowing the remaining $50 resulted in a 20% gross return on your invested capital of $50. If the interest on the loan is less than 10%, your net rate of return will be higher using leverage.

Good debt can also help you diversify your investment portfolio, such as using a loan to buy stocks in other companies when you hold a concentrated stock position in a single company.

Intriguing read: Do Medical Bills Drop off after 7 Years

Some examples of financial leverage include liquid asset secured financing, home debt, and estate planning debt. Liquid asset secured financing, like a home equity line of credit, allows you to access liquidity without selling assets and potentially incurring capital gains taxes.

Liquid asset secured financing may be a good option for you if you need to generate cash flow quickly, and it offers the benefit of lower-interest rates as it's a lower-risk option.

Related reading: What Is a Good Debt to Asset Ratio

Bad debts can sink your finances, and it's essential to know what to avoid. Bad debts do not help make your financial life better; they cost more than they're worth and can even put you at risk for bankruptcy.

Predatory loans, with their sky-high interest rates and confusing pay down terms, are particularly problematic. Payday loans are an example of this, with interest rates often exceeding 100%.

Revolving debt is usually bad, especially when it comes to credit cards that take money out of your pocket in interest and fees. Credit card interest rates tend to be egregiously high.

Broaden your view: Bad Debt Provision Accounting

Car loans can also strain your balance sheet because a car's value quickly depreciates. As a general rule, try to avoid using debt to buy stuff that won't earn money or appreciate in value.

High-interest credit card balances and lines of credit impede wealth building by draining cash flow. Reverse mortgages, often marketed to retirees, have drawbacks, including giving the lender a stake in your home or your heirs' assets.

Debt with variable interest rates can erode your net worth at an inopportune time, especially if you can't easily pay off the loan. Most retirees should try to avoid taking on interest-bearing debt, particularly with a variable interest rate.

Intriguing read: Chapter 13 and Car Loans

Debt management is crucial for small business owners.

Consider what type of debt you'll have, as good debt is tied to an asset that won't depreciate over time, such as education, real estate, or your own business.

Healthy debt involves borrowing money for investments in items that don't depreciate. Try to use funds to reduce a loss or catastrophe.

Your interest payments are tax-deductible, which can bring you above the red line into profitability.

Debt can be a heavy burden, but it doesn't have to be. Bad debts, in particular, can drag you down and even put you at risk for bankruptcy. Avoiding bad debt is key to managing your finances effectively.

To determine whether a debt is good or bad, you need to review your possible monthly payment. Can you realistically afford the new bill? Be honest with yourself – it's better to say no now than to struggle with payments later.

Look at the interest rate too. The lower the interest rate, the less interest you'll pay over the life of the loan. This can make a big difference in the long run, so don't overlook this crucial factor.

Bad debts can be sneaky, but they're not always necessary. Think about your long-term goals before taking on debt. Will borrowing this money help or hurt you in the long run? Ask yourself this question before making a decision.

You might enjoy: What Is a Good Long Term Debt to Equity Ratio

Here are some key things to consider when evaluating a debt:

By considering these factors, you can make informed decisions about debt and avoid bad debt traps. Remember, debt doesn't have to be a bad thing – it's what you do with it that matters.

When evaluating debt investments, consider the type of debt you'll have. Good debt is borrowing money for assets that won't depreciate over time.

Healthy debt is all about borrowing for investments that hold their value, such as education, real estate, or your own business. If you borrow money for these types of investments, it's considered good debt.

One strategy to use when taking on good debt is to commit to the lowest interest possible. This can actually work in your favor, especially when you consider that interest payments are tax-deductible.

These tax deductions can bring you above the red line into profitability. Interest rates can actually work for you instead of against you if you play your cards right.

Intriguing read: What Happens to Credit Debt When You Die

Liquid asset secured financing can be a good option if you need to generate cash flow quickly, offering lower-interest rates and the benefit of not having to sell assets, which can lead to capital gains taxes.

This type of financing is like a home equity line of credit, but instead of being secured by your home, it's secured by your investment portfolio.

You can use liquid asset secured financing to fund special purchases, pay a tax bill, or refinance higher interest rate debt.

Here are some uses for liquid asset secured financing: