June 13, 2012
-- Not all debt is bad and when used intelligently, it can help you to build credit and wealth. Mortgages and real estate, business, and student loans are considered good debt while auto loans, credit cards, and department store credit cards are categorized as bad debt. In general, good debt creates value and produces wealth in the long run. When we speak of debt reduction, however, things get more nuanced. If you have a credit card with a 20 percent interest rate and apply for a home equity loan at 6 percent, this is good debt. Refinancing to get rid of hefty interest rates is normally good debt. The same is true for buying high-return bonds, stocks, and other investment instruments.
Speaking of mortgage loans, the chance that you can buy a house with cash is slim. Obviously, the larger the down payment, the less you will pay in interest charges over time. It may look like a good idea to deplete your savings account and make a large down payment, but it is not. There are other issues to consider, including taxes, monthly expenses, and your need for cash reserves.
Buying durable goods or disposable items on a high-interest credit card creates bad debt, especially if you make the minimum payment only. The problem is that many cardholders are not organized enough to pay the balance in full before the due date. The bank charges interest for every month that the borrower makes a partial payment. Meanwhile, the durable or disposable item bought on credit continues to lose value while the amount paid increases.
Generally, good debt is incurred for things that you need but cannot afford, and bad debt includes anything you do not need and cannot afford. Borrowing makes sense if you have to choose between a personal loan and liquidating your investments or closing your savings account. In some cases, people borrow to make money work harder for them. If the interest is low, compare what your money would earn, if properly invested, and what you would spend on interest charges. For more information on loans please visit: http://www.yourloan.ca/