Until recently there was no such thing as ‘good debt’ or ‘bad debt’ as all debt was ‘bad debt.’ Owing money for any reason wasn’t a good thing and it was important to focus on paying off everything.
But now we are hearing about having ‘good debt’ and having ‘bad debt.’ So what’s the difference?
‘Good debt’ is considered to be funds that you borrow to purchase an appreciating asset. Something that may grow in value such as real estate, a business or investments.
‘Bad debt’ would be money you borrow to purchase a depreciating asset – cars, boats, clothes, consumables – or something that you can’t afford. Something that quickly loses value or doesn’t generate any revenue. It is most likely at a higher interest rate and even if the rate is low today you should also factor in a higher rate and potential fees to ensure that you can afford it in the future.
High interest rate credit card debt is considered ‘bad debt.’ Credit cards themselves are not evil if they are used prudently and balances are not carried over.
Mortgages are considered ‘good debt’ because real estate generally appreciates over a period of time although there are no guarantees. You are also borrowing at lower interest rates.
Home equity lines of credit, which are a type of mortgage, can be either ‘good debt’ or ‘bad debt’ depending upon what they are used for. If you are using your line of credit to purchase depreciating assets or using it for your day-to-day expenses, it would be considered ‘bad debt.’ Consolidating your high interest credit card debt into a home equity line of credit would be ‘good,’ as there would be a significant lowering of the interest rate.
Car loans would be ‘bad debt’ as you are purchasing a depreciating asset, but unfortunately the reality is that this is the only way that most people can afford a vehicle. The best thing to do is pay cash or as much cash up front for a car as possible. Does everyone really need a fancy new car?
Pay day loans or cash advance loans are definitely ‘bad’ as the interest rates and fees are astronomical.
In reality, it can be argued that no debt is ‘good debt’ – but used in moderation and with an educated approach, debt can assist in many things, including investing for retirement planning.
Using credit cards for everyday expenses and not paying them off right away is a dangerous path. Recently TD Canada Trust announced changes to how interest on their branded credit cards will be calculated. With the change, the bank will start to add any unpaid interest charges to the cardholder’s balance at the end of each statement period. Currently TD calculates interest based on a cardholder’s average daily balance until that amount has been paid in full. As a result you will now be paying interest on unpaid interest.
Prudent borrowers maximize ‘good debt’ and minimize ‘bad debt.’ It is possible to overuse good debt so be careful.
If you are experiencing any financial challenges and currently own your home please reach out, as there may be solutions to relieve financial stress.
This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.