Set Screen Reader On Set Screen Reader Off
Need Help
Feedback
Products

Good Debt Versus Bad Debt: Do You Know the Difference?


It's almost impossible to live debt-free. Most of us can't shell out cash to pay for the cost of a house or a college education. We usually take out loans to do those things and that kind of debt makes sense. But what about that designer pair of shoes you put on your credit card? Or that motorcycle you've been dying to get for those weekend road trips? Is that debt worth having?

There is a big difference between good and bad debt, and it's important to know the difference. You have to learn which debt makes sense and which debt you should avoid.

Good debt

Most financial experts agree that good debt includes investments that will grow in value or generate long-term income for you. For example, if you take out a student loan to pay for college, you are increasing your value as an employee and raising your potential future income. That would be an example of good debt. Here's a list of examples that are considered good debts to incur:

  • Your home. Purchasing a home can be a good long-term investment and the interest rates are generally low. In addition, the interest you pay on your mortgage is tax-deductible.
  • College education. Student loans typically have a low interest rate and oftentimes you don't have to make any interest payments until after you graduate. In addition, college is usually a good way to increase your earning potential. If it's your child's education, consider drawing on several other financial resources first - including scholarships and grants.
  • Automobile. This one can be tricky. A car's value drops drastically the second you drive it off the lot, so you have to be careful. Ask yourself some questions. Is the car helping your long-term financial health? Is it necessary to get to and from your job? Will it save you money to buy a more fuel-efficient car? Once you answer these questions, shop around for the least expensive, most reliable car and pay it off as quickly as you can.

Bad debt

Bad debt is incurred to purchase things that quickly lose their value and do not generate long-term wealth. Bad debt also carries a high interest rate. For example, if you charge a $500 shopping spree on your credit card, you may end up paying more than double that amount for the clothes if you can't pay the entire balance off right away. Here are some other examples of bad debt:

  • Clothes, consumables and other goods and services. Things like clothing, vacations, food, groceries and gasoline are considered bad debt because they either decrease in value or get consumed. Putting these items on a credit card means you end up paying more for them when you factor in interest (unless you pay the card off in full each month).
  • Credit cards. Credit cards are a bad form of debt because the interest rates on these cards are often significantly higher than the rates on other loans. If you keep a balance on your credit card, you will wind up paying much more than the actual charges by the time you factor in the interest. It's important to try to pay off any credit card debt you have - starting with the card with the highest interest rate.
  • Retail store credit cards. Oftentimes retail stores offer a low interest rate or a chance to save 10 to 20 percent the day you open the card; however, you may be required to pay for the items in full at the end of a certain period or risk being charged a high interest rate dating back to the day of the sale.
  • Payday loans or cash advance loans. These kinds of quick loans are some of the worst! They often charge you a fee to get the loan upfront and the interest rates can be as high as 300 percent!
  • Furniture, appliances and home remodeling. It is tempting to borrow money for these big-ticket items, but be careful. Furniture does not add value to your home and many remodeling projects don't either. If you find yourself in a situation where you have to replace a broken washing machine or something, do your research and try to pay for the item as quickly as possible.

Ways to control your debt

A general rule to avoid bad debt is if you can't afford it and don't need it, don't buy it. But that's often easier said than done, right? Many people have large credit card bills that they are trying to pay each month. Here are some suggestions for getting your debt under control:

  • Record your monthly spending. Figure out how much money you need each month for your fixed expenses such as mortgage or rent, utilities and groceries and how much you spend on variables such as entertainment, coffee and dinner dates.
  • Create a new spending plan. Figure out what you bring in each month and use that number to determine how much you can put toward your debt each month. You can increase what you put toward your debt by eliminating some of the variable expenses that are unnecessary.
  • Review your fixed expenses, too. You may be able to refinance your mortgage to get a lower interest rate or call your credit card companies to see if they'd be willing to lower your interest payments.
  • Make a list of your ‘bad debts' and all the interest rates. Pay off the debt with the highest interest rate first while continuing to pay at least the minimum payment on each of your other debts.
  • Seek assistance. As a military family, there are several resources available to help you get your finances in order - including counseling on a range of issues such as budgeting, spending plans, debt consolidation and much more. Review the information at the end of this article for where to go for help.

Your credit score

Your credit score indicates how much of a credit risk you are. Creditors use this information to gauge how like you are to repay your debts. Scores usually range between 300 and 850 - the higher the score, the better.

One of the biggest factors that contributes to your credit score is the amount of debt you have. To score your credit, they consider the ratio between your credit card balance and your credit limit for each of your credit cards. The higher your credit card balances are relative to your credit limit, the more it hurts your score. So a maxed-out credit card is bad news! Here are a couple of additional things to consider:

  • If you miss payments on your debts because you can't afford to make them, you'll lose credit score points. Missed payments of 30 days or more are often reported to the credit bureaus and will impact your credit score.
  • Paying off your balances quickly helps to raise your credit score because you're lowering the amount of debt you have versus your allowed debt limit.

Your credit score has a direct impact on your ability to borrow money or receive a low rate on a future purchase - such as a car loan or home mortgage. Carrying a lot of debt, especially high credit card debt, hurts your score and your ability to get approved for new cards and loans. You can order a free credit report from each of the three major credit bureaus to review your score and assess how you can improve it. The Federal Trade Commission website provides the information you need.

Get assistance

The Department of Defense provides a range of services and support to help military families get their debt under control and achieve financial stability.

  • Personal financial counseling is available through Military OneSource at 800-342-9647. Counselors can provide one-on-one assistance with budget development, debt consolidation (including helping you contact your creditors and negotiate late fees), housing issues (such as being behind on your mortgage payments or foreclosure) and money management.
  • The Personal Financial Management Program on your installation has personal financial counselors who can provide education and counseling services on a wide range of topics including credit use and abuse, spending plan development, debt liquidation, financial goal setting and more. To contact your local program, visit MilitaryINSTALLATIONS.
  • The Federal Trade Commission's website offers a lot of great articles and resources related to money management. The Consumer Information section walks you through how to get a free credit report, what to do if you're facing foreclosure, how to deal with debt and much more.
  • The Consumer Financial Protection Bureau offers an entire section of their website devoted to military members and their families and the particular financial concerns they may have.

WEBINAR

All Webinars
July 23, 2014
Caregiver Identity Discrepancy
Learn more and register for the webinar

INSTALLATION PROGRAM DIRECTORY

RSS FEED

All RSS

Stay up to date on all things related to Service and Family Members.
Subscribe to the Service and Family Member RSS feed