Good Debt vs. Bad Debt
Is there such a thing as a good debt? Depending on who you talk to, you will get different answers. Although it might be tempting to paint a black and white picture by saying, “all the debt is bad,” you would be mistaken. The picture has more nuances than simple black and white pigments.
Is There Such a Thing as Good Debt?
First, we must define the debt to understand the answer to the question. When you purchase something with money that is borrowed, you incur debt. Fundamentally nothing is wrong with debt. Its value to you depends on what originated the debt. The most important question is whether it’s an asset or a liability?
Any debt carries with it interest. In the world of finance, interest can work either for or against you. When you carry debt on liabilities, it works against you. When you carry debt on an asset, the picture is not as clear.
Assets hold some for of value. They could be income generating such as a business. They could also be stores of wealth, such as a home. When the interest you earn from the asset exceeds the debt’s interest, it might be a good investment.
Good Debt vs. Bad Debt
Liabilities are a terrible debt. The most common type is the credit card. They carry high-interest rates. Plus, people do not usually buy investments on their credit cards.
The only debt that is a good debt generates income for you. This could be from asset appreciation or some other income source. Rental homes are a popular way for people to use debt to create income.
Comparing Yields and Interest Rates:
If you pay more on the interest for the debt than you earn from the income, it creates it is not a wise investment.
How to Get Out of Debt
The first step towards building wealth is getting rid of your debt. All of your debts carry interest that works against you. As soon as you get those out of the way, everything else will be much easier.
Minimize Other Expenses:
The first step for minimizing expenses is to first have a way to track your expenses to see where you are spending your money. Money tracking and budgeting is the first step to understanding what areas you need the most help. A great way to save money is to assess monthly expenses, since they come every month the savings can add up. Whether it is saving on your food expenses by ditching the take out or saving on your AGL bill by investing in efficient appliances or cancelling unused subscriptions, the savings can turn into a significant amount of money
Pay Off Highest Interest Debts First:
Pay off your debts in the order of the highest interest to least. Put all of your money toward the debt that carries the highest interest rate first. Make only the minimum payments on your other debts. Once that account is closed, follow the same process for the second-highest interest rate debt.
Pay More Than Minimums:
Finally, Pay more than the minimum, even if it is only by a small amount. Most of your minimum payment does not go towards the principle of the debt. That means that it is essentially wasted money. Every dollar that you pay over the minimum will pay off the principle on the account. This helps you get rid of the debt quickly and minimizes the amount you will pay on interest.
The Bottom Line on Debt: Keys to Wealth Building
It isn’t easy to accumulate wealth when you have to pay 1/3 of your income and interest each month. Unfortunately, in today’s economy, we are required to finance most of our purchases. Modern technology is expensive, albeit necessary. Once you are done paying off all of your debt, it will be much easier for you to accumulate wealth. After you get rid of your bad debt, only use your credit to finance assets that generate income for you. That way, all of your debt works for you instead of against you.