Most people think of “debt” as a bad thing. The truth is to build your credit you have to have some debt. And there is such a thing as “good debt.” The difference between good debt and bad debt is that good debt builds your net worth or helps you generate future value and bad debt does not. Using “good debt” responsibly can make you richer, whereas bad debt simply holds you back from your financial goals. Read on to learn how you can use good debt to help you reach your goals and increase your net worth.
Debt should be used to help you achieve your financial goals and this measuring stick can help you determine what is considered good and bad debt.
Debt that can be deemed a smart investment is good debt. We’re not talking about getting a loan to collect every Pokemon card, although to some that might be considered an investment. Good debt generally includes mortgage loans and student loans. If you are a savvy shopper and the market is in your favor, the value of your property should appreciate over time. Learn about factors that will increase the chances of a home’s value appreciating.
The idea with student loans is that you are investing in your education and you should receive a return on your investment with your successful career after completing your degree. Of course, it will take much more time and effort to get a return on your investment if you attend an expensive private school vs a top notch state school. Be smart with your investment.
Bad debt is everything else that doesn’t help you grow your net worth or reach your financial goals. It includes credit cards and other high interest loans, like payday loans. In general, if you are using debt to finance discretionary spending (shopping, vacations, etc.), then it’s bad debt. It’s easy to see that debt that drags down your financial situation and supports an irresponsible lifestyle is bad for you.
Using a credit card responsibly is an easy way to build your credit, however it becomes bad debt when you are carrying a balance month after month. To use a credit card to build your credit, you should pay it off in full each month and only spend what you know you can afford. You can even get cash back or rewards points on your purchases.
Gray Area: Auto Loans
Financial experts disagree about whether car loans are good debt or bad debt. The answer is really dependent on the situation and the consumer. Since most new cars depreciate as soon as they are driven off the lot, it is most likely not an investment that will appreciate over time. However, if you look at the situation like we did with student loans, then if your car supports your successful career and enables you to make more money then it does have a return on its investment. This might also be true for rare and collectible vehicles. You should shop around for auto loans and for the car itself and learn some negotiation tactics to help you get the purchase price of the car down.
Set Your Financial Goals
The compass that will help you your entire life to determine what decisions you should make and what habits you should develop is having financial goals. Now the goal isn’t to be richer, there’s more to it than that. But being “rich” is determined by a person’s net worth, which includes the assets, like houses and cars, that they possess. Many of us can’t buy a house or car with cash, but we can take the necessary steps to get a loan and pay it off responsibly so that we do own it later on when its value has hopefully appreciated.
One goal setting strategy is to make “smart goals” for this year, 2 years from now and 5 years from now. Even if you are struggling to make ends meet, make this year’s goal to pay off some specific amount of debt or save $1,000 for an emergency fund. You can make your 2 year or 5 year goal to buy a car or a house. Take some time and grab a pen and paper (or your phone) and write down what your goals are for those 3 time frames.
Whatever goals you have, learn how to achieve them and then don’t stray from the path. Paying off debt or saving more money includes making a budget, cutting costs and maybe even having a side hustle to make more money. Buying a car or a house involves saving for the down payment, improving your credit so you can get approved, having steady income and much more. There are many steps to achieving just one financial goal, so know all of the to do items you need to check off.
Financial freedom begins with good habits.
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