subject: Bad Debt Versus Good Debt [print this page] The word "debt" has a bad vibe given our huge government deficits and the out of control credit card and home buying that took place before the housing bubble burst. Believe it or not, there is such a thing as good debt. In fact, the only way to establish a strong credit score is to take on debt and then demonstrate your ability to make your payments on time every month.
There are subscription services available to consumers which are a low cost way to gain a closer understanding about your credit. For example, the credit score estimator available on one of these services helps you plan ahead to see how big financial decisions, like applying for loans or maxing out credit cards, may impact your credit score.
What Is Good Debt?
Different types of debt are treated differently by the formulas used to calculate your credit scores. For example, a mortgage debt is factored differently than a credit card. Having a lot of different credit card accounts and little else on your credit report shows that you may rely heavily upon revolving credit to make ends meet.
Some types of accounts reflect more positively on your credit report because of what can be inferred about your financial habits. Sometimes you may need to take on debt as an investment in the future. For example, a student loan is usually considered good debt. The idea with student loans is that it should lead to better, higher paying employment later on. On the other hand, using credit card debt to pay for nice dinners and extravagant vacations could be interpreted as bad debt (unless you pay off your credit card in full every month).
Overall, almost any debt can be considered good debt if you are able to pay it back on time each month, making at least the minimum payment due.
What Is Bad Debt?
A debt can be considered bad if the debt is more than you can afford. It may be tempting to purchase a luxury car over an economy car, but if the monthly car payments will be difficult to meet on time each month, then it is unwise to take on the higher car loan.
Another example of bad debt is when you max out your credit cards. A big factor in determining your credit score is how much of your credit you are using. If you have a mastercard with a $10,000 limit and you have used most of that up, you've taken a potentially good debt into a bad one. Even if you make your monthly payments on time, the fact that you are using most or all of that credit line negatively impacts your credit score. It is best to stay within a range of 25 to 35% usage of a credit line, if you must carry over any credit card debt month after month.
Services offered by the services which are available deliver credit score alerts to you so that you find out when your credit score changes. This knowledge could help you qualify for better interest rates and lower monthly payments on new loans.
In summary, bad debt is debt that you take on to pay for a lifestyle that you cannot afford. Sacrificing your long term financial health for short term gratification takes you down a dangerous path.
