Good Debt vs. Bad Debt

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Being debt free is the ultimate financial goal for most people. There are many articles advising us how to get out of debt, that we may automatically assume that debt is a bad thing. However, not all borrowing is bad.

There are many occasions when debt can actually be a good thing, here are a few examples.

1. Buying a homeMany people cannot afford to buy a house without borrowing.  A mortgage is a big debt, but it is a better financial proposition than renting. Getting a mortgage is like having an investment for the future. It offers the prospective of living debt free in 25-30 years. Furthermore, because it is secured against the value of your house, the interest rate is likely to be relatively low.

Carefully consider how much you can afford to put down and how much of a loan you can carry. The more you put down, the less you'll owe and the less you'll pay in interest over time.

2. Student loansIt is unfortunate that taking a student loan is almost an essential aspect of going to University or College, however, the gain is a good long term investment. A good degree or diploma creates the potential for higher earning power and this extra income is greater than the debt incurred.

It is unwise to borrow against your home to cover for your children’s tuition. If you run into financial difficulties down the road, you may risk losing your home. Your best bet is to save what you can for your kids' educations without compromising your own financial health. Then let your kids borrow what you can't provide, especially if they are eligible for a government-backed student loans. Such loans have guaranteed low rates; no interest payments are due until after graduation; and interest paid is tax-deductible under certain circumstances.

3. Building your credit historyBorrowing through loans or credit cards helps you build your credit history. However, in such cases, you should arrange to pay the credit card balance on monthly basis and avoid paying high interest on the purchasers made on your credit card.

4. Loans for investmentsSome of your debt might be considered an investment. If you took on the debt to purchase something that will increase in value and can contribute to your overall financial health, then it’s very possible that debt is a good one.

Avoiding debt at any cost is not wise if it means depleting your cash reserves for emergencies. If the debt is used to purchase an asset, make sure that the utility or financial return from the asset is higher than the cost of debt. It is also important to ensure that you are not overleveraged where your borrowings exceed your assets or where you have trouble servicing the loans. Any debt which is taken after you are overleveraged is not advisable, regardless of its purpose.