Good Debt Versus Bad Debt

By knowing the difference between good and bad debt, you can better manage, and reduce, your debt.

When struggling to repay debts – credit card bills, car payments, student loans – it’s hard to think of any debt as particularly good. Think again, as it turns out, that’s not exactly the case. Some debt is better or worse than others, and knowing the difference is important.

For starters, debt is debt; however, the distinction between good and bad is based on the purpose for which the debt is taken on. Bad debt is used for the here and now; good debt helps one get ahead financially.

The Good

Good debt is like an investment – a home, a piece of land, or even stocks – it is taken on in order to purchase something with value that will increase in the months and years to come.

The Bad

Credit cards are the most common example of bad debt. Most Canadians have more than one credit card and credit cards typically carry high interest rates, meaning the balance owing can quickly balloon in size, and usually has substantially higher carrying costs. If not paid off on the due date, the carrying cost compounds at this high rate and the amount owed just builds and builds.

The Reality

For potential homeowners, the difference between good and bad debt is important. Carrying high credit card debt or available credit can mean trouble for those trying to secure a mortgage. It can reflect poorly on personal credit history and rating. Banks base their decision to lend for major purchases on the borrower’s proven ability to repay; if the evidence isn’t there, lenders may be less likely to approve the desired mortgage.

Tips for Overhauling Spending Habits

• Concentrate on paying off your debt first, to avoid accruing interest while avoiding accumulating more debt.
• Save ahead for purchases. Lower the amount of household budget allocated for this spending and put those dollars towards paying down your bad debt.
• When it comes to credit cards, you should always pay the monthly minimum.

Source: A Better Way to Home Ownership, Spring Summer 2022, Sagen