Understanding the difference between a good debt and a bad debt is not that complicated once you understand the principle of the idea. Most Americans assume that all debts are bad; they are just one of the necessary evils of modern life. However, in fact, not all debts are a bad idea, some can be very helpful, and others can be very destructive. All debts can be labeled as good or bad.
Good debts can be defined as ones that will prove helpful to you financially or otherwise in the future. These debts should actually not be considered as debts, it would perhaps be more prudent to think of this type of debt as an investment.
Some examples of debts that could be reconsidered as viable investments are loans like a mortgage. A mortgage has two benefits, without a large loan to purchase your house; it is quite possible that you would never be able to save enough money to pay in cash. Therefore, you would be throwing away money every month on rentals rather than owning your own home. In the end when you sell your house it will have accumulated a considerable amount of equity. This can be tens or even hundreds of thousands of dollars; this is money you would never have had, if you had not invested in a mortgage.
A business loan is another example of a debt that is really an investment. Taking out a loan to start, or enhance your business should, in theory at least, increase your income above the amount that you are paying for your loan.
There are some good debts that do not have a direct financial benefit but still clearly be interpreted as investments. A student loan is the prime example of this kind of non financial benefit. A good education does not translate dollar for dollar as an investment.
Nevertheless, as we all know, if you achieve a high level of education the chances of you finding a good quality job are vastly increased. Although it may be many years before you see anything viable from your investment in education. In the end, your student loan should be a paid back many times over, with a better paying job, which is not only financially rewarding, but also mentally stimulating.
Good debts are loans that in the short or long term, will produce a financial or other reward, that is greater than the amount that you had to pay in principle and interest.
Bad debts on the other hand, will not provide any kind of return on the investment, apart from a temporary feeling of well-being. The worst offenders in the area of bad debts are credit cards. Credit cards offer the temptation of quick and easy payment, they also carry high interest rates, and the biggest contributor to individual debts in America after medical bills.
Credit cards are a simple way to increase bad debts, the purchase of a new big screen TV may give you a feeling of well-being, but that does nothing to increase your personal wealth.
The purchase of the TV with your credit or store card will only lead to increased interest payments and a larger personal debt. You should consider if you would have ever purchased the TV, if you had to pay in cash that you had saved.
Bad debts on cards or other non productive loans such as car financing do nothing to increase your personal wealth. They simply increase your debt and the amount that you have to pay out each month without giving a viable return.
You could of course argue that the new TV does pay you and your family back with hours of entertainment. This of course is true; the problem is that it is not just the TV that you financed. You have purchased multiple items, big and small, with your credit cards and other loans. These have now multiplied into a large-scale total debt, which may take many years to pay off.
If you need to acquire a great new item for your home, the best way to finance it, is by waiting and saving. The TV that you purchased a year ago is worth far less than half of what you paid, add to that the interest payments that you will be making for another two years, and the TV is worth a fraction of what you paid for it. This can only be interpreted as bad debt.
Once you get your head around the concept of what is a viable investment type of debt, and what is a financially draining debt. It is them much simpler to decide which items you should purchase with a debt and which are best avoided or paid for with real cash that you have saved.