We hear all the time that debt is bad. There are books, seminars, and programs that are all designed to teach you how to get debt free and live debt free. But is that really necessary? Is all debt truly that bad? Believe it or not, the answer is no. Not all debt is bad.
This post has been sponsored by Lexington Law. All opinions are mine alone and are honestly conveyed.
While living debt free is definitely not a bad goal, having debt can offer benefits to you. Such advantages include tax deductions—on mortgages, student loans, or business loans; ability to build a solid credit history; and the opportunity to take advantage of discounts or even interest free short term loans. When leveraged properly, you can actually use debt to your financial advantage.
How much is too much debt?
But, of course, the opposite is also true—not all debt is good either. So how do we figure all of this out? How can you tell which types of debt are good and which are bad? Let’s begin by understanding that living paycheck to paycheck and feeling crushed by a mountain of debt that you may never be able to repay is definitely bad—and you don’t want to be in that situation. However, carrying smaller amounts of debt and making regular payments each month can help to increase your credit score and build a solid credit history.
What are considered good types of debt?
There are some good types of debts. Mortgages, student loans, and business loans are all debts that you can incur that are considered a good debt? Why? Because these types of debt are taken on with the idea that they are an investment into your future and will put you in a better financial situation down the road by appreciating in value or generating long term income. While there is no guarantee that a home that you buy will appreciate in value, or that you will be able to find a good job with a college degree, or that a business that you invest in will succeed, investing in these areas may be worth the risk.
Good types of debts can also help build your credit history. Mortgage payment history, for instance, is a debt that can provide the opportunity to build a long term payment history—and if those payments are on-time month after month and year after year, they can really help your credit score.
Your score is based on length of credit history
Older accounts increase your score because part of your score is based on the length of your credit history. So if you have payments that have been made on-time for several years, such as with a mortgage, this helps to increase your score. For instance, if you have established a long-term credit card or home equity line of credit, it is better to have a small balance on them or pay them off each month rather than closing them. Besides the age of the account, it will also show that you have access to quite a bit of credit with a low balance, which is another factor that increases your credit score—low balance to credit line ratio.
Debt is better than a Bankruptcy
While having a lot of debt—especially debt with late payments—does not look good on your credit report, a bankruptcy would look worse. In fact, a chapter 7 bankruptcy will show up on your credit report for 10 years. Even if your credit score would go up after a bankruptcy, you may still be penalized by lenders for a recent bankruptcy. While you may feel that you are suffocating under a mountain of debt, you may want to try working with your creditors to get caught up so that you can start making regular, on-time payments. Most creditors will work with you if you are serious about getting your payments back on track.
What is bad debt?
An example of a bad debt is a credit card. Why? There are a few reasons that credit card debt is considered a bad type of debt. Credit cards typically charge a very high interest rate. Yes, you may be able to get a promotional rate on new charges or on balance transfers for a few months, but after that time period, the interest rate likely goes up to 15-25%, depending on your credit score. So money that you have on those credit cards is being charged a very high rate of interest until the balance is paid off. Credit cards also are “bad” because they are a revolving debt, meaning that the interest is accrued daily—as opposed to a simple interest loan, which would be compounded monthly. Because of this daily compounding effect, and typically at a very high rate, it can be very hard to ever get a credit card paid off if you have a large balance and are just making minimum payments.
Can a credit card ever be a good debt?
Surprisingly, the answer is yes—but only in certain circumstances. Here are a few instances of when having a credit card debt can be beneficial to you:
- Using a store card for a discount—many stores offer special discounts for their in-store credit card use. If you use the card to take advantage of the discount, that’s great! But you need to make sure to pay off your credit card balance every month. Even if you get a discount for the purchase, if you keep a balance on the credit card, you will likely cancel out any benefit you may have received with a discount by the daily accruing interest.
- Use a credit card for a promotional offering—sometimes, you can use a credit card to make a large purchase, such as for furniture, and have a certain time period in which to pay off the entire balance interest free. The caveat, however, is that if you don’t pay it off during the interest-free period, all of the accrued interest will be added onto your balance. The important thing to remember during this time is to pay more than the minimum payment and ensure that you can have the balance paid off before the promotional time period ends.