Good debt vs bad debt

The amount of personal debt is ever increasing, and a large part of the reason is that credit has never been easier to get. In the beginning, credit card issuers looked for customers, who could repay and restricted the limits for those who were questionable. Now card issuers salivate at the opportunity to snare those who'll continuously charge beyond their means at 18 or 20 percent. And they’ll show their appreciation by constantly increasing your credit limit.
Debt is a complex concept. Being given credit isn’t always a good thing. This fact catches a surprising number of people off guard until they're in the hole, deep in a hole. On the other hand not all of it is bad. When used intelligently, debt can be of tremendous assistance in building wealth.
One of the secrets we’ll share with you about being smart with your money is to differentiate between good debt and bad debt. While the differences often seem logical, this logic is missed by many North Americans.
"Buying something that goes down in value immediately, or has real value other than to yourself, is bad debt," says Ward Willison, co-author of “Win the Debt Game”. "If it has zero potential to increase in value, that's bad debt. Take a walk through your home. You’ll see thousands of dollars invested in bad debt."
Good debt
"Good debt creates cash flow. It will appreciate whether you do anything with it or not.” If you go into debt buying an apartment or a commercial building that will produce revenue and deductions, that's good debt. Mortgage debt is good debt. You're borrowing money, but you're getting a tax advantage and can write off interest on an asset that's appreciating over time. Other good debt can be to take out an RRSP loan and use the extra money on your tax refund to pay off the loan.
Ward Willison, self-made millionaire and entrepreneur, also recommends taking on debts that are tax-deductible, and debts that produce more wealth in the long run.
A smart person will take their recurring debt that from their credit cards that are up in the 17 – 19 percent range and eliminate them with a home equity loan of 6 or 7 percent. The loan can be tax-deductible. You’ll gain twice with this strategy.
To further increase the value of this “good debt” you should destroy the credit cards and eliminate the chance to create the bad debt again and take the money you are saving and generating and invest it. Portion some of the cash flow to paying off one debt at a time and the rest to be put into a financial vehicle for creating wealth.
Bad debt

Bad debt comes in the form of purchases of disposable items or experiences or things that wear out. Many of these purchases are made with high interest credit cards.
The problem is, people don't feel like they are spending real money when they use their credit cards. It can seem so harmless to lay down the plastic card, sign your name and walk away with your new treasure. People don’t realize that credit cards are just plastic cash. Typically they are stunned to see how often they do one of these harmless transactions and how much they owe by the following month.
It is a completely different experience to give a cashier a one hundred dollar bill or a handful of twenties for your purchase than it is to swipe your card and jot down your name. When you hand someone cash, it's so clear that you’re giving away something that you won’t get back. How often have you decided to use your credit card when you had enough cash in your wallet? Your reasoning is that you don’t want to part with your money because you know once you give away there is a huge empty spot in your wallet where your money used to be. Not a good feeling.
The real killer with making those purchases is that not only will you pay the price on the tag but also the interest tacked on by the credit card company. This is especially bad when you consider that purchase will devalue by at least 50% the moment you walk out their door. Now that is bad debt!
Where bad debt can be most damaging is what it can do to your credit rating.
“Never let your debt-to-income ratio rise above 20 percent," says Mike Hassard, financial analyst, Primerica. “It won’t matter if you’re making your payments on time and your record is spotless, you’ll appear as a potential risk you because you could be getting in over your head."
Driving into debt
Another bad debt area is auto debt. Most people would do some serious reconsidering about taking the bus or cycling to work if they ever sat down and calculated the cost of owning and operating a vehicle. The average citizen wouldn’t dream of driving down the road throwing away thousands of dollars from the open window of his/her speeding vehicle but that is what happens the minute they drive off the lot. Their new car devalues several thousand dollars immediately. That is bad debt.
The smartest move and probably the hardest is to leave your ego at home when you shop for a car. As much as we’d like the vehicle to be an extension of our personalities it is and always will be only an automobile. Look at it as transportation and you’ll hang onto a lot more of your money. When it comes to your vehicle, buy what you need not what you want.
According to Edmunds.com the average new car loses 12.2% of its value in the first year. On a $20,000 car, that's $2,440, or more than $200 a month. Some cars depreciate even faster, depending on demand, incentives offered and other factors.
A wise buyer will buy used letting the other person take the financial hit. Along with being able to save money, you'll pay less for insurance. The Cars of today are better built and last longer than ever before. You can tell this by the length of the warranties offered. Some companies offer a ten-year 100,000 km warranty.
Companies like CarFax allow you to trace a car's history. Many late-model used cars are still under warranty. As with any larger investment you’d be wise to take along an expert. Utilize the services of a trusted mechanic and give your potential purchase a close up inspection
So now you know that debt comes in different forms, both good and bad, choose wisely.

 

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