Debt Management - Good Debt Versus Bad Debt

For effective debt management it is important to understand the difference between good debt and bad debt. It is actually very simple.

Bad Debt

Debt that is accumulated for the purpose of purchasing liabilities is bad debt. How do you tell if something is a liability? Well, if it doesn’t put money into your pocket every month, it’s a liability.

This is generally what you call “consumer” debt and is the most expensive type of debt. And even worse, too much bad debt impedes your ability to invest and achieve financial freedom.

The easiest bad debt to recognize is buying a big screen TV or stereo for your home on credit. These items clearly do not generate income for you. Generally speaking, if the items being purchased are disposable and/or continue to lose value (depreciate), the related debt is bad debt.

Debt that is accumulated for the purpose of purchasing assets is good debt. How do you tell if something is an asset? You’ve probably already figured out the answer to this question. If it puts money into your pocket every month, then it is an asset.

For example, borrowing to purchase rental real estate that generates rental income monthly would be an example of good debt.

While a student loan would not generate income immediately, it is usually inexpensive debt and will help you earn money in the future. Therefore one could possibly call it a good debt.

Using these definitions, would the mortgage on your home be considered good debt or bad debt? Well, given the fact that your home is not generating an income each month and therefore is technically a liability, making the mortgage a bad debt.

Of course, everyone has to live somewhere whether they pay rent or make a mortgage payment. The purpose of this example was simply to illustrate the differences between good debt and bad debt.

Practice good debt management and focus on reducing and avoiding the “bad” or credit card debt as much as possible, or at least the higher interest rate debt. This consumer debt is undermining your financial security.

If you already have a substantial amount of bad debt, there are a number of options that can help provide debt relief such as debt consolidation, settlement, credit counselling and do-it-yourself debt reduction.

Next time you consider purchasing an item on credit, ask yourself, is this going to put money in or take money out of my pocket every month. By making better choices and avoiding bad debt, you have taken the first step in the management of your debt.

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