Good debt, bad debt, what’s the difference? How does each affect your credit score? What are some examples of each? If you’ve ever wondered how good and bad debt affect your credit, you’ve come to the right place. Here you’ll learn what good and bad debts are, and how it affects you and your credit history.
What’s the Difference?
The terms “bad debt” and “good debt” refer to the same thing in a way: a debt. However, each of these has different factors and qualities that make them different and affect how they impact your personal credit. Good debt is usually a long-term investment like a college education, whereas bad debt often refers to short-term financing or impulse buys, like credit cards and material items.
How Does Each Affect My Credit?
Good debt is borrowed against something that will increase in value or make more money in the future. Business loans and college loans often fall into this category. The future value of the initial loan is greater, and is therefore considered to be a good investment. If you pay on time every month and get your loans paid off, this can drastically increase your credit score and history. These options also look a lot better on a credit report; showing creditors that you’re not spending your money on just anything.
Bad debt in the form of credit cards or other financing to purchase items that depreciate in value over time can affect your credit in two ways: usually, these financing options have higher interest rates, making them more difficult to pay off, and usually come with higher late fees and penalties.
While both good and bad debt can help you improve your credit score, good debt looks better on a credit report and tends to actually have a payoff in addition to improving credit history. The old saying “you have to spend money to make money” is all too true. To improve your financial future, you’ll need to spend money in a good way, so the initial investment will pay dividends in the future. Credit cards and short term loans do not serve to build a financial future, but instead, bring us instant gratification for the things we can’t wait for.
If you’re struggling to get your credit or your monthly budget under control, a financial advisor may be able to help. Read this list of the best financial advisors in Dallas for more information on their services and pricing.
Credit Cards: With high-interest rates, short repayment times, and plenty of late fees and penalties, credit cards can be incredibly dangerous in terms of financial security. Not only are credit cards easy to acquire, but they’re also incredibly easy to use; therefore serving only as a temptation to spend more than you can afford.
When you use credit cards, be sure to keep your balance well below the maximum threshold, and always pay your monthly obligation on time and in full. In fact, it’s better to always pay more than just the minimum payment amount. If you can’t afford more than that, you probably shouldn’t have the card to begin with.
Car Loans: As soon as you drive your car off the lot, its value drops. Car loans are a necessary evil; but you don’t always need the newest most flashy vehicle. A lot of people fall into the trap of financing brand-new vehicles, not realizing that a car doesn’t actually increase in value or even retain its original value. You’ll be paying thousands of dollars for something that will be worth less than its original cost in just a few years.
Material Items: Let’s be honest; most of us have certain material things we love. Whether you love electronics, clothing, or some other material thing, you’re likely spending money every month on these items. Many people acquire credit cards or other short-term financing options simply to satisfy these material needs. These items usually don’t hold their value over time; making them bad investments.
College Loans: The idea behind acquiring a college education is to place yourself in a career in which you can make more money than you currently do. Since this investment usually creates a result that includes an income boost, it’s considered to be good debt. Education also increases your ability to find employment, which can help you widen your options (and therefore your earning potential).
Small Business Loans: Making money with a small business is a dream for many Americans, and those that make it happen might have started with financing in the form of small business loans. This type of debt is incurred for the purpose of making more money; it’s an investment that can pay off big time later on.
Home Loans: While a vehicle may be a poor investment, a mortgage on a home can be an excellent investment. Whether you’re mortgaging a home to live in or to rent out to someone else, there are endless ways to increase your profitability with real-estate; making it a good investment and a type of “good debt”.
Good and bad debt affect your credit in similar ways, but with good debt, you’ll likely see a payoff at some point. Bad debt is really only incurred when we need financing for things we don’t actually need. We all get sucked into the trap at some point; the new handbag, TV, or car can be incredibly alluring. It’s important to remember that setting yourself up for a more stable financial future will allow you to have those things without having to borrow money to obtain them.
To read more on topics like this, check out the money category