How Good Debt Can Go Bad

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Have you heard someone say, “debt is fine as long as it’s ‘good’ debt?”  The idea of good debt is defined as using debt to purchase something that will appreciate in value.  Some view it as a tool that helps you meet your goals faster and more easily.  Here are four common sources of ‘good’ debt and how these debts can actually turn bad.

Home Mortgages

Paying cash for a home is very difficult, so the majority of homeowners have used mortgages to help them fulfill their dreams of owning a home.  Responsible borrowing can be a great tool, but these foolish uses of debt can turn that home loan into a nightmare.

  • Buying a home that’s beyond your budget. This is known as becoming ‘house poor.’  Struggling just to make a house payment can be dangerous and put you into a tight financial situation.
  • Borrowing extra to upgrade your home or remodel rooms. Yes, remodeling your home can increase the value, but you never want to get upside down because of ‘extra features’ you thought would increase the value.
  • Taking a second mortgage or refinancing to pay down credit card debt. This doesn’t solve the root of the problem – which is the inability to properly manage credit cards.  This move can often put you further behind as the credit cards start to build again and the extra mortgage payment restricts monthly cash flow.

Bad DebtSchool Debt

Using school loans is oftentimes necessary for students to obtain a college degree.  Being conservative with these loans will help with managing the payments.  Beware of foolish practices like these:

  • Using extra loans to eat out and live beyond your means. You can live like a student now, or live like a student later as you struggle to repay the extra loans you took to eat out every weekend.
  • Purchasing vehicles with student loans. Transportation may be a necessity, but buying a car with student loans isn’t the most prudent thing to do.  Instead, save up for an affordable used car or use public transit to commute for a few years.
  • Not planning for repayment. If you are studying to work in the nonprofit sector, racking up $80,000 in debt will put you in a world of hurt.  Project the payments for your school loans and don’t overvalue your hopeful industry’s salary range.

Business Loans

Small business loans can be a great jumpstart for your business, but these factors may have you thinking twice before getting into ‘good’ debt for your business.

  • Research thoroughly before borrowing. Before you begin any business, make sure you’ve done your research to see if your venture will thrive.  Failing to do careful research can result in a failed business and financial troubles if you borrowed to start the business.
  • Restricting terms can be challenging. Business loans are often locked into a term and many don’t allow for restructuring.  If you are struggling as a business, the lack of flexibility may have negative consequences.
  • Increased interest rates. The interest rates on small business loans can be higher than home and auto loans, so weigh this carefully before you commit to this kind of debt.

Real Estate Loans

Investing in real estate beyond your primary residency can be a risky, yet rewarding business.  The following risks can turn this good debt into a bad investment, so proceed with caution when considering a loan for real estate investments.

  • Uncertain market conditions make investing in this industry even riskier. Not understanding the economic factors involved with real estate could make your investment a poor choice and turn that good debt into a big regret.
  • Repairs can be costly.  Maintenance on real estate properties can get expensive, especially if you’re not a handy-person.  Small repairs can add up and using a line of credit or more loans can make the situation even worse.

Yes, debt can be a good tool to help you succeed in business and to grow your investments.  However, calling these four types of debt ‘good’ all the time isn’t smart.  Every debt situation should be approached with caution, because ‘good’ debt can turn bad quickly if it’s used improperly.

image credit: respres

Comments

  1. says

    I wish someone had given me this advice years ago! When I graduated from College, I had some student loans, not much, and a small amount of credit card debt. My employer paid for some of my tuition to the point that I had a $10,000 check ready for me at the end. Did I pay off the loan? The Credit Card? nope — bought a car, and further, the car was about $20,000 total, meaning I took on an additional $10K. That’s a decision I wish I could revisit!

  2. says

    I had a friend awhile back who actually put paid for part of their wedding using student loans. Their reasoning was that the interest rate available to them on a student loan was much, much cheaper than taking out a personal loan or putting it all on credit cards.

    • says

      If I had a friend who asked my opinion about the idea of paying for a wedding with student loans…I’d probably tell them it’s a bad idea.

      I understand the math behind the interest rates, but the underlying question is do you really want to start your marriage with an extra load of debt? Going to debt TO get married is a slippery slope that will probably lead to even more bad decisions about credit. (I’m not trying to say they were foolish to do that, but I think that specific use of credit should be avoided.)

      Thanks for sharing this Joe

  3. says

    Debt can be classified as either good or bad, but that doesn’t always mean that one form of debt is any worse for you than another. It is the way you use and manage debt which often defines whether it is a good idea or a bad idea for you to borrow more money.

  4. says

    Man, it bugs me when people classify student loan debt as good debt. It’s good only after you’re reaping a nice return on that education you used it to pay for. As for real estate loans, I think many people are far too optimistic with their calculations. Which is why so many real estate investors end up bankrupt.

  5. says

    We live in times of bad economy where lots of people have a need of borrowing money. Really, we take out mortgages, vehicle and school loans, use credit cards and etc because it’s better for use to borrow and then pay back partly. But I think that it’s worth to pay more attention to buying for cash and avoid multiple debts. When you have borrowed once there’s a risk that you will borrow twice and in the end get into the debt circle. Decision to borrow money can not be taken lightly, it’s worth to think well and make sure that you will be able to repay.

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