These experts say not all debt is bad: Here’s how to make debt work for you
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There’s a lot of doom and gloom surrounding the state of credit card debt in America, with 44 percent of cardholders carrying a balance month to month, according to Bankrate’s Chasing Rewards in Debt Survey. Not to mention, average credit card interest rates currently hover above 20 percent. But what about other types of debt?
It’s true that credit card debt and other forms of consumer debt can come with high interest rates and possibly hurt your credit score if they’re mismanaged. But it’s also fair to say that not all debt is bad debt.
When used wisely, debt can be a force for good in your life. But it’s important that you have a good understanding of what you could gain from your debt and how you’ll repay it.
I talked to two financial experts about how to use debt to improve your credit and grow your wealth. Here’s what they had to say.
Bankrate’s take: With responsible use, good debt can help you build credit and invest in an asset or your net worth.
What is good debt vs. bad debt?
Some financial advisors believe that all debt is bad. Others advise against thinking of debt as universally bad, and instead say that good debt grows your value, while bad debt decreases it.
“Good debt is debt that has the potential to increase your overall net worth and benefit your financial situation long term,” says Monique White, head of community at Self Financial, Inc. She mentions mortgages, business loans and student loans as examples of good debt.
“Ultimately, credit is a tool,” White says. “Instead of categorizing it as good and bad, I think it’s about making sure you understand how to use the tool to your benefit.”
Debt for things like doom spending and discretionary spending probably won’t grow in value. But other debt can.
Good debt can be viewed as an investment into your financial future.
— Monique White Head of community at Self Financial, Inc.
3 ways you can use debt to improve your financial health
Before taking out that loan or applying for new credit, take a moment to consider what you might gain from it. If the three benefits below are possible, you may have a good financial decision on your hands. But if you’re looking at potential unpaid balances, high interest rates or depreciating assets, that debt might not be the right move.
Here are three green flags for debt.
1. Build your credit
The best way to build strong credit? Using credit responsibly. By making on-time payments, staying well below your credit limit and having a long credit history, you can improve your credit score over time. And a good credit score can help you access better loan rates and the best credit cards on the market.
As White puts it, “Credit is the foundation for your financial well-being.
“A strong credit score allows you to say ‘yes’ to big life milestones like buying a car, owning a home, and makes all the difference when you want to apply for credit products,” White says.“Good debt can have a positive impact on your credit score because it demonstrates responsible credit usage and repayment behavior.”
Certain credit-building products could fall into the category of good debt. Just keep in mind that poor credit habits could have the opposite effect on your credit score. Even good debt, when mismanaged, can be harmful to your credit.
2. Pay for an asset
If you take out a loan to invest in an asset that appreciates — or gains value over time — that could be a form of good debt. Ryan Moore, financial advisor at TBS Retirement Planning, says that “if the purpose of debt is an investment or a tool used to create wealth, the debt is good.”
“For example, your house could be considered good debt,” he says. “If your home costs $300,000 and you get a loan, you instantly gain $300,000 worth of real estate.
“Another example could be investing in a business that produces revenue. Not only have you increased your net worth, but now you may have an income stream that helps you pay off debt and increase your wealth,” Moore explains.
Taking out a mortgage or business loan could be a smart financial move, as long as you can afford the monthly payments in addition to the set interest rate. The value of the home or business could end up far outweighing the debt’s cost (though it’s worth noting that values can fluctuate and fall as well).
3. Invest in your net worth
Finally, an investment in yourself can be an investment in your wealth. “A wise investor will use the bank’s money to increase their own portfolio, knowing the use of the money is going to increase both their own as well as the bank’s net worth,” Moore says.
This might include paying for an educational degree, certification or skills training to help advance your career and grow your net worth. In this case, you are the appreciating asset.
Student loans can be a form of good debt, as long as you end up earning enough income to repay it over time. If you’re responsibly using a student credit card to pay for your everyday expenses while in school, that could be another example of a credit product that is working for you.
The bottom line
Debt doesn’t have to be a dirty word. Good debt can help you build credit and reap value in the long run, like investing in a home or an education. You’ll just want to crunch the numbers and make sure you can afford repayments.
But Moore cautions that if someone is “using their own income to pay off a debt on something of losing value, then they are losing wealth over time.” Before applying for that loan, consider what you have to gain — versus what you might have to lose.
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