Here is a common question we get: Is it okay to be in debt?
Some may argue that no debt is good debt. However, for many people, borrowing money and taking on debt is the only way to purchase big-ticket items or kick off their dreams, such as buying a house or starting a business. Taking out loans to purchase homes or kick start a carefully planned business is usually justifiable and provides value to the person taking on the debt. However, there is another end of the spectrum where debt is taken on carelessly. While it can sometimes be easy to differentiate between two ends of the spectrums, sometimes it can be hard to decide just what debt is valuable and what debt can be a poor decision.
When looking at borrowing money, there are many types of debt to consider. Debt can be broken into two categories: good debt and bad debt (also known as productive and unproductive debt). Read on if you're interested in finding out how certain kinds of debt can help you in the long run.
What is good debt vs bad debt?
Good or productive debt is essential in wealth creation. Have you ever heard the saying: "it takes money to make money?" Well, it’s true. Debt can be productive and positive... if it helps you build your net worth by generating an income. Borrowing money that improves you and your family's life in significant ways can also be considered good and positive.
On the other end of the spectrum, bad or unproductive debt happens when you borrow money to buy a depreciating asset. Put simply, that’s an item that won't go up in value or generate income. These types of things shouldn't be purchased on a loan or credit if at all possible. If you are buying them using a credit card, make sure you can pay off the entire balance every month. In the long run, unproductive debt can lead to consumption instead of wealth creation, and you'll be paying interest on something that won't be a return on the investment.
What kind of debt is good debt?
So what kinds of things are worth going into debt for? Here are a few of the most common things:
Generally, the more education an individual has, the higher their earning potential. Education also has positive connections with the ability to find quality employment. An investment in a college education, a technical degree, or a trade school can often pay for itself within a few years of entering the workforce. However, this also largely depends on the type of degree you pursue. Not all education and degrees are equal, so it's worth considering both short- and long-term outlooks for the fields of study that interest you before you commit to taking on any debt.
Launching a business
Borrowing money to launch your own business can also fall under the heading of good debt, with the appropriate precautions. While being your own boss can be financially and psychologically rewarding, it can also be hard work. Similar to paying for an education, starting a business can come with its risks. But when calculated carefully, those risks can be fruitful. Although many ventures fail, the chances for success are greater if you choose an area where you are passionate and knowledgeable.
A personal home or other real estate
Making money in real estate can come in many varieties. On the resident side, the most straightforward often involves taking out a mortgage to buy a house. After living in the home for a few decades and potentially making improvements to it, more than likely, you can sell your home for a profit. While living in your home, you can enjoy the freedom of having your own home plus a variety of possible tax breaks that are not available to renters. On the flip side, real estate can also generate income by short or long-term rentals, whether residential or commercial.
What kind of debt is bad debt?
Now that we've discussed some of the things that can be worth going into debt for, let's look at the items that aren't good to buy with borrowed money.
From a financial standpoint, buying a car with a loan or credit is not the best idea. By the time the vehicle leaves the lot, it is worth less than when you bought it. However, many need cars for transportation to get to their jobs or other critical reasons. If borrowing money to buy a car is necessary, look for a loan with little to no interest. Since a car is technically a depreciating asset, paying as little interest as possible on it is the best move.
Clothing items and consumables
It's typically regarded that clothes are worth less than half of what is listed on their initial price tag. Take a look at consignment or used clothing stores. Oftentimes even half the original price is generous. Of course, everyone needs clothes -- they also need food, furniture, gas, and many other things! But buying these items on credit, especially with a high interest rate, isn't a good use of debt. Although a credit card can be used for convenience, make sure to pay off the balance in full every month to avoid interest charges.
Create, cultivate, and thrive with Delta Wealth Advisors
Debt can be a tricky business. Even the things worth going into debt over have their risks. When searching for financial clarity, look no further than Delta Wealth Advisors. We are a financial firm built on the values of hard work and collaboration. Our advisor will fight for every edge of our client's finances. Schedule your complimentary call today to get started with our financial professionals.