Highlights:
- Some types of debt can be advantageous if managed responsibly
- "Bad debt" can be any debt you're unable to repay
- Learn steps you can take to avoid bad debt
Did you know there actually can be such a thing as good debt? Many people mistakenly think all debt is bad, but there are certain types of debt that can be advantageous when it comes to your credit.
So, what is “good debt"?
Speaking generally, debt that you're able to repay responsibly based on the loan agreement can be "good debt," as a favorable payment history (and showing you can responsibly handle a mix of different types of debt) may be reflected in credit scores. In addition, "good" debt can be a loan used to finance something that will offer a good return on the investment. Examples of good debt may include:
Your mortgage.You borrow money to pay for a home in hopes that by the time your mortgage is paid off, your home will be worth more. In some cases, you can deduct the interest on mortgage debt on your taxes. Home equity loans and home equity lines of credit — which are a type of loan in which a borrower uses his or her home as collateral– may also be considered a form of good debt. The interest payments on these are tax-deductible as long as you use the loan for its intended purpose: to buy, build or renovate the home used as collateral.
Student loans can be another example of “good debt.” Somestudent loans have lower interest rates compared to other loan types, and the interest may also be tax-deductible. You’re financing an education, which can lead to career opportunities and potentially increasing income. However, a student loan becomes a bad debt if the loan is not paid back responsibly or within the terms agreed upon. It can also become burdensome if you have so much student loan debt that it takes years (and more interest payments) to repay.
Auto loans can be good or bad debt. Someauto loans may carry a high interest rate, depending on factors including your credit scores and the type and amount of the loan. However, an auto loan can also be good debt, as owning a car can put you in a better position to get or keep a job, which results in earning potential.
What is “bad debt”?
Simply put, “bad debt” is debt that you are unable to repay. In addition, it couldbe a debt used to finance something that doesn’t provide a return for the investment. Debt could also be considered "bad" when it negatively impacts credit scores -- when you carry a lot of debt or when you're using much of the credit available to you (a high debt to credit ratio).
Credit cards, particularly cards with a high interest rate, are a typical example. If you can’t pay your credit cards in full every month, interest payments can prolong the debt.
High-interest loans -- which could include payday loans or unsecured personal loans -- can be considered bad debt, as the high interest payments can be difficult for the borrower to pay back, often putting them in a worse financial situation.
What to Do to Avoid Bad Debt
If you’re making a purchase that increases your debt,ask yourself how this purchase will benefit you – not just today, but long term. Is the debt you’ll incur going to provide you a lasting benefit, or is it something that will satisfy an immediate desire that you can’t afford?
It’s also a good idea to have a rainy-day or emergency fund for unexpected expenses, so you won’t have to use credit cards to pay them.
Try to keep your debt to credit ratio (the ratio of how much you owe compared to the total amount of credit available to you) as low as possible to avoid being viewed as a risky borrower by lenders. Focus on paying the debt you have and restrict new purchases.
Lastly, it’s always important to pay your bills on time, every time.
FAQs
Debt can be considered “good” if it has the potential to increase your net worth or significantly enhance your life. A student loan may be considered good debt if it helps you on your career track. Bad debt is money borrowed to purchase rapidly depreciating assets or assets for consumption.
How do you understand debt and credit? ›
Credit is the loan that your lender provides to you. It is the money you borrow up to the limit the lender sets. That is the maximum amount you can borrow. Debt is the amount you owe and must pay back with interest and all fees.
Is a car loan good or bad debt? ›
Some auto loans may carry a high interest rate, depending on factors including your credit scores and the type and amount of the loan. However, an auto loan can also be good debt, as owning a car can put you in a better position to get or keep a job, which results in earning potential.
What is bad credit vs good credit? ›
What does it mean to have bad credit? Under the FICO scoring model, people with poor credit have scores between 300 and 579. Get your score between 580 and 669 and you'll move into the fair credit range; bump your score past 670, and you'll achieve good credit.
What qualifies as bad debt? ›
Simply put, a bad debt is a type of expense that occurs after repayment by a customer (when credit has been extended) is no longer considered to be collectable. In other words, bad debt is an irrecoverable receivable.
What is a good debt example? ›
Examples of good debt are taking out a mortgage, buying things that save you time and money, buying essential items, investing in yourself by borrowing for more education or to consolidate debt. Each may put you in a hole initially, but you'll be better off in the long run for having borrowed the money.
What is an example of credit vs debt? ›
Debt is amount of money you owe, while credit is the amount of money you have available to you to borrow. For example, unless you have maxed out your credit cards, your debt is less than your credit.
What is the basic understanding of debt? ›
What is debt? Debt is something (usually money) borrowed by one party from another. Debt is used by both individuals and businesses to make purchases they couldn't otherwise afford, and gives them permission to borrow money under the condition it is paid back at a later date.
Can you be in debt and have good credit? ›
The most creditworthy consumers don't have high scores because they are in debt; rather, it's because they likely have a variety of different credit products, such as credit cards and installment loans like a mortgage, that add up.
What are two things which might change your FICO score? ›
Highlights: Even one late payment can cause credit scores to drop. Carrying high balances may also impact credit scores. Closing a credit card account may impact your debt to credit utilization ratio.
Mortgages are seen as “good debt” by creditors. Since the mortgage debt is secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use. They also see home ownership, even partial ownership, as a sign of financial stability.
What is bad debts with example? ›
For example, if a company sells its products on credit to a customer who fails to pay according to the terms agreed upon, the sale will be considered a bad debt after all efforts to recover the amount owed have been exhausted.
Does good credit really matter? ›
In addition to having higher credit approval rates, people with good credit are often offered lower interest rates. Paying less interest on your debt can save you a lot of money over time, which is why building your credit score is one of the smartest financial moves you can make.
Is a 500 credit score good or bad? ›
Your score falls within the range of scores, from 300 to 579, considered Very Poor. A 500 FICO® Score is significantly below the average credit score. Many lenders choose not to do business with borrowers whose scores fall in the Very Poor range, on grounds they have unfavorable credit.
What counts as bad credit? ›
What is a bad FICO credit score?
- Poor: 300-579.
- Fair: 580-669.
- Good: 670-739.
- Very Good: 740-799.
- Exceptional: 800-850.
Bad Debt Example
A retailer receives 30 days to pay Company ABC after receiving the laptops. Company ABC records the amount due as “accounts receivable” on the balance sheet and records the revenue. However, as the 30 day due date passes, Company ABC realises the retailer is not going to make the payment.
What is good and bad debt in business? ›
Good debt drives your business forward, helping you to grow faster, while bad debt can constrain growth or even threaten the survival of your company. A smart approach to good and bad debt means reviewing your debts and prioritising repayments.
Is bad debt a gain or loss? ›
Under the direct write-off method, bad debt expense serves as a direct loss from uncollectibles, which ultimately goes against revenues, lowering your net income.
Is a mortgage a good or bad debt? ›
Mortgages are seen as “good debt” by creditors. Since the mortgage debt is secured by the value of your house, lenders see your ability to maintain mortgage payments as a sign of responsible credit use. They also see home ownership, even partial ownership, as a sign of financial stability.
