Thursday, August 7, 2008

Good Debt And Bad Debt - What's The Difference?

by Aussie 0 comments

Most of us go into debt at some point in our lives, either by choice or out of necessity. It might be a car loan to finance the purchase of your dream car. It could be the mortgage you need to buy a home for you and your family. It might even be the credit card debt you build up each month (and hopefully pay off within the interest-free period).

But I'm surprised at how many people I've met who have got their personal finances in a mess through the imprudent use of debt. So today, I'd like to put forward some ideas of how you can use your capacity to borrow for good rather than evil.

What Is Bad Debt?

In general, any money which you borrow to buy something which goes down in value could be considered bad debt. This might include so called lifestyle-type assets like expensive cars or consumption items like clothes and food. Money borrowed to finance a vacation would fit into this category as well.

Your credit card is quite often one of the main accomplices in racking up unhealthy debts. This is because credit cards are normally used to buy everyday items - food, clothes, going out to dinner and so on. Then when the balance on the card is not paid off at the end of the month the problem is compounded. At interest rates which often exceed 20%, this is a very costly exercise.

What About Good Debt?

Ideally, the only time you would borrow money would be to buy an asset which appreciates in value or produces income. The total return from the ownership of the asset would need to exceed your borrowing costs in order to advance your goal of building wealth.

An example might be investing in real estate. You would expect to receive some income from such an investment which would help service the interest payments. In addition you would hope to see some growth in the value of your investment as well.

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