Debts are a part of every individual’s life. Every body takes debt, whether it is short term or long term. But it is important to strike a financial balance – our expenses and debts should always measure up against our income. To understand which debts are ok and which should be handled with care, you need to know the difference between a good debt and a bad debt.
Good Debt
Your credit report contains a detailed account of all your debts. When a lender goes through it, he looks on certain debts as favorable. For example, when you buy a home, you might have taken a mortgage on it and are making payments towards it. Since a home is an asset with a value that appreciates with time, it becomes more of an investment and less of a negative debt.
The same thing can be applied to college tuition fees. Investing in education means that your earning potential will improve and hence education can also be perceived as an investment, which will yield you good returns in future. Any debt on an undertaking that can improve your financial position from a long term perspective is a good debt.
Bad Debt
When you accumulate debt because of spending on perishables or expenditure not of a lasting nature, you term it as bad debt. For example, expensive clothes, dining at fine restaurants, automobile purchases and costly holiday trips may run into innumerable large bills if you are in the habit of enjoying expensive things and luxury. It may be within your means where your income easily covers your liabilities or it may be beyond it. If these are beyond your means, you are likely to accumulate a big credit card debt.
Credit card balances are unsecured debts and attract high rates of interests and additional charges, when you revolve or default on the payments. Other example of bad debts is a personal loan taken for non-investment expenditure. Bad debts in short are loss making propositions.
If you are struggling with bad debts on your credit report, now is a good time to change your habits and start some financial planning. The present lending market is favoring low income loans and refinancing at a reduced interest rates. So if you are stuck with bad debts, you can opt either to renegotiate the terms of your existing contract or take a new loan with lower rates to settle your outstanding debts and start afresh.
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