Good Debt and Bad Debt

Some financial experts say all debt is bad debt. Others say that student loans and mortgages are good debt while credit card debt is bad debt. The truth is, debt itself is fairly neutral, but it can be used in good or bad ways. Excess debt is never a good thing, and sometimes good debt can turn into bad debt. For example, taking out a mortgage to purchase a house that later falls in value can turn a good debt bad, as many people with "underwater" mortgages can attest. Generally speaking, bad debt is debt that you have little or nothing to show for: trips, clothes you don't really need, or meals out.

Your Mortgage: Good Debt?

Historically, mortgages have been viewed as good debt. For decades, the common assumption was that housing prices would continue to climb. The housing crash of 2008 showed that assumption to be incorrect. Just how good your particular mortgage debt is depends on several things:

• Whether you can afford your mortgage
• Local trends in housing prices
• The interest rate you have on your mortgage
• Rental prices in your area

The main exception to the "mortgage debt equals good debt" is a second mortgage used to pay off credit card debts, because your home itself won't show any improvement from the debt.

Student Loans

Like mortgages, student loans have long been thought of as good debt. After all, a college education sets a person up for better earning potential, right? In general yes. However, college costs have gone up far more rapidly than inflation, and even students in high-earning study programs (like medical or law school) graduate with tens of thousands of dollars in debt that they'll pay back over many years before they can fully enjoy their earning power. If you're considering student loans, make sure that your school has a good record of graduates landing decent jobs. If not, you should consider looking at other schools.

Credit Cards that are Paid off Monthly

If you charge things to your credit card, but pay off your balance every month, it's good debt, because you get the convenience of shopping with plastic (plus cash back or other rewards with some cards) without paying interest charges. However, the more typical method of carrying a balance on a high interest credit card is not good for your finances. At an average interest rate of over 15%, you're paying a lot to be able to purchase things now rather than saving up for them.

How to Distinguish Good Debt from Bad

To determine whether a debt is potentially good or bad, ask yourself the following:

• Is the debt for something you actually need, or something you want?
• Will the purchase make your life better?
• Will the debt cause you and your family financial hardship?

As you can see, any debt can be good or bad, depending on how you handle it. But once you have all the debt you can comfortably afford to service, any additional debt should be considered as bad debt and should be avoided until you are able to pay down existing debts.

Sources:

http://money.cnn.com/2011/06/17/pf/expert/debt_free.moneymag/index.htm
http://www.bankrate.com/finance/debt/rethinking-good-debt-vs-bad-debt.aspx
http://abcnews.go.com/Business/good-debt-bad-debt-secrets-borrowing/story?id=14270866&page=2#.Tv3L2jVrPw0
http://technorati.com/business/finance/article/good-debt-and-bad-debt/
http://www.credit.com/blog/2011/09/good-debt-versus-bad-debt/