We’re taught from a young age that buying items you can’t afford is a bad idea and getting into too much debt has serious consequences. However, as we get older, we learn that in certain instances, incurring debt for necessary and worthy expenses can be a positive thing.
In the simplest terms, good debt lets creditors know that you can afford payments when you enter into an agreement. Having a favorable credit rating – a result of the proper mix of assets and debt – allows you to get a favorable rate on loans for large purchases. On the other hand, a bad credit rating can be used as grounds for denial or a less favorable rate when you are looking to buy home insurance, renters insurance or car insurance, among other things, according to the Federal Trade Commission.
So what is good debt to have? In the most general terms, carrying good debt means taking out credit to pay for things you need but may not be able to afford up front. Good debt should carry manageable monthly payments, leaving you plenty of cash to spare for day-to-day expenses, according to a guide provided by CNN Money. Here are two common examples of good debt:
* Student loans: Education loans usually carry favorable rates and can be paid back over a long period of time with reasonable payments. They are government-backed loans often carrying the most favorable terms and interest rates. Student loans are often the easiest way for young adults to begin establishing their credit standing.
* Home mortgage: While having a good credit score will help you get a favorable rate on a home loan, entering into a mortgage agreement and making timely and regular payments can go even farther to help you strengthen your score. Good credit will also help you secure favorable home and property insurance rates and making consistent payments on those items will help your credit score in turn.
In both of these cases, your debt is considered a good thing because that debt can potentially put you into better financial standing. If you go into debt to finance your education, you are increasing your earning potential. If you go into debt to buy a house, you are increasing your personal wealth when you make payments to build equity. On the opposite side of the coin, if you take out a loan to buy a car and the car dies before you pay off your loan, you would owe money on something that holds no value.
When you are thinking about taking out a loan, the best question to ask yourself is whether you will be better off financially once you’ve paid off the balance of the loan. While taking out debt to live without your means is a bad thing, taking out loans that can result in the eventual accumulation of wealth through reasonable monthly payments can strengthen your financial position.
