Good Debt and Bad Debt: Borrowers Are Better Off When They Know the Difference

Debt is truly a double-edged sword — a blessing when used thoughtfully and selectively but a curse when overused and relied upon indiscriminately, says FPA member and CERTIFIED FINANCIAL PLANNER™ professional Devin Pope of Albion Financial Group in Salt Lake City, Utah. “There is good debt, when it’s used as a positive tool that enables a person to acquire assets or skills that ultimately improves their financial standing, but that would otherwise not be attainable with capital on hand. That kind of debt generally makes sense for a person to carry on their balance sheet.”

On the flip side, there’s bad debt. That can be when a person takes on debt — and the extra cost typically associated with it, known as interest — without the means to pay off the debt in a timely fashion, according to the agreed-upon terms attached to that debt. Bad debt also can be debt a person takes on unnecessarily, when they could just as easily have used cash on hand to pay for an item rather than assuming the extra financial burden that interest brings, or simply if a person assumes additional debt to make what is clearly a frivolous, unnecessary purchase. Or it can be debt that a person takes on for the right reasons, but without adequate due diligence. Getting a mortgage makes good sense for a person acquiring a home, for example. But if that person could easily have found a mortgage with a significantly lower interest rate simply by shopping around a little, then their decision to accept the higher rate, and the tens of thousands of dollars in extra interest payments it may cost them over the life of the mortgage, turns that loan into something less than “good debt.”

With so much potentially at stake, anyone who’s either already a borrower or considering taking on debt in some form, via a car or student loan, mortgage, line of credit, credit card, etc., should have a clear understanding of the distinctions between good debt and bad. Here’s a look at the two sides — financially constructive and financially destructive — of debt. .
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