Good debt versus bad debt - what's the difference?
When most people look at the word "debt" they only think about negative things. Perhaps your mortgage pops to mind, or all those credit card bills you have. The thing is, not all debt is bad. There is both good debt and bad debt, although many people are not able to differentiate between the two. Good debt and bad debt are very different and can have various outcomes. Here is a closer look at both types of debt so you can more fully understand how debt works and know more about when good debt that is managed properly can actually be a good thing in your life.
What is Bad Debt
First of all, let's take a look at bad debt. This is the type of debt that we probably think of when the word "debt" comes up. Often you get started out after college with a lot of different student loans and several different credit cards too. Then you add on a car payment, and before you know it you have a mortgage added to the mix. All of these debts begin to weigh on you and they quickly add up. With the high interest rates, it can be difficult to stay on top of this debt, and soon you are in over your head before you even realize it.
The reason this is called bad debt is because this type of debt is working against you. A mortgage is the one exception, since it actually does help you to build a future, which is a positive thing. Bad debt occurs when you spend too much on things you don't really have to had, and this money is spent on things that won't bring you any return on the investment you have made in them. When you spend a lot of money on items that give you no return and you go into debt for them, this becomes a very big problem.
What is Good Debt
On the other side of debt you have good debt. This type of debt is very different. In many cases you may hear this type of debt called leverage. What this means is that you take the debt to make money in the future for yourself. One example is investing in a new business. The business is supposed to bring in $300,000 each year for the following 10 years. It is going to cost you about $30,000 to invest in this opportunity but you don't have the money on your own. You can take out a loan, which is a debt, for this money, but in the end you will get about ten times the amount of what you initially invested in the opportunity. This is what is known as good debt, since this debt is working to make you more money. Of course, if you go into this type of debt you have to figure out what kind of return you'll be able to go and how much you are willing to invest to get returns.
If you know how to use it in the right way, good debt can be very powerful and can actually help you to make a lot of money instead of costing you the way that bad debt does. However, whenever debt is handled in a bad way, it can cause a myriad of financial problems. If you can get involved in good debt though, it can actually be the cure for your financial woes.
Tips for Eliminating Your Bad Debt
If you do have a lot of bad debt, the good news is that there are a variety of different things you can do to work on eliminating this debt. Here are a few excellent tips that can help you to eliminate your bad debt to work on improving your financial state.
Tip #1- Stop Spending More Than You Have - Too many people spend more money than they have. Most Americans fall into this trap. If you want to eliminate your bad debt, then you need to break this habit.
Tip #2 - Save Some Money - Another problems people have is not having any savings. In order to eliminate your bad debt, saving some money will be an important part of getting out of debt. Having enough savings to last for about three to six months is important so you are not in a bad situation if for some reason you don't get income for a few months, which can happen if you lose your job or deal with medical issues.
Tip #3 - Start Spending Cash - Instead of whipping out the credit cards and getting further in debt, start spending only cash. Save a credit card for emergencies, but otherwise spend cash so you don't overspend.
Tip #4 - Negotiate with Creditors - In many cases creditors are willing to negotiate interest rates and repayment terms. They don't want you to end up in bankruptcy because they have a bigger chance of losing money. If you can negotiate a lower interest rate alone, this can save you a lot of money and enable you to get rid of bad debt much faster.
Tip #5 - Cut Back on What You Spend and Pay Extra on Debts - Work to find ways you can cut back on your spending. Stop eating out, consider buying used items, and cut excess spending that isn't needed. Use the savings to start paying extra on your debts so you cut that bad debt down as fast as possible.
Tip #6 - Pay on Time - Make sure you pay your bills on time. Every time you pay late, you not only hurt your credit rating, but you end up with fees. This is added to your debt, increasing the amount of bad debt you have.
Tip #7 - Work to Pay More than the Minimum Due - Many people get stuck in the endless circle of bad debt when they only pay the minimum payments. This doesn't cover interest in many cases. Essentially you never really bring down the debt when you do this. Paying more than the minimum due can help you to actually bring down the amount of debt that you owe.