Learn how types of debt affect your financial future
Did you know there’s such a thing as good debt? It’s true - debt is not all bad. “Good” debt can refer to money borrowed for things that can improve your financial future or net worth over time, while “bad” debt can refer to credit cards and other loans that do not serve a long-term purpose or increase in value. However, if well-managed, both types of debt can help build your credit. Below we’ll explore a few common examples of debt and how each can impact your financial picture.
Many students will take out loans to finance collegiate or postgraduate education. This investment is considered good debt because a higher education can lead to more job opportunities and increase your earnings potential. In turn, that income is used to pay back the debt. However, it’s important to save deliberately while in school so you’re able to make payments after the 6-month graduation grace period, even if you haven’t started a job yet.
A mortgage loan is considered good debt, because each monthly payment builds equity in your home. The property becomes a financial asset, and depending how long you stay in the home, you could sell it at a profit or even pay off the loan in full.
Be aware that you may qualify for a higher loan amount than what your budget can truly afford, which could make it difficult to sustain monthly payments. Some home loans also include an adjustable interest rate that fluctuates based on the market rate, causing your payment to fluctuate as well.
Auto loans are typically labeled as bad debt because the vehicle often depreciates in value when you leave the dealership, which means your loan principal is already higher than your car’s current value. But, a vehicle helps you get to and from work, which is vital to your income. So, this type of debt can be positive or negative depending on your ability to repay the loan and the interest rate. If you need a car loan, securing a low interest rate will help you pay less over the loan term, keeping your total investment closer to the value.
Credit cards are a type of revolving credit. Revolving credit does not have a fixed repayment timeline, so you can continue pulling from the same line of credit up to your limit. Credit cards help establish and build your credit history, but because of the high interest rates and low minimum required payments, the debt can snowball quickly.
It’s important to evaluate the items you’re buying on credit to determine if they bring a longer-term value to your life. For example, if you’re buying meals and clothing consistently on credit, is that worth the upfront cost plus any interest you accrue?
Credit cards can prolong debt if not managed. A best practice is using less than your credit limit and only spending what you know you can pay back in full each month.
Take a moment to review your current debts and your financial goals. Are they aligned? If taking on new debt, will you earn back more than the initial investment? For more assistance with debt management and budgeting, explore our FREE, online Education Hub or contact our banking advisors today!