Money Matters

GOOD DEBT VS. BAD DEBT

Opinions regarding the appropriate use of debt are many and varied. Some financial advisors suggest that debt is harmful in all instances while others suggest acquiring as much debt as possible, so long as it is used in a particular way. While making sense of many, often conflicting, viewpoints may prove challenging, what is clear is that there are several fundamental considerations when attempting to discern good debt from bad.

1. Total debt load

The first and most important consideration related to debt is whether you can afford the payments. Based on their research and experience over many years of lending, mortgage companies have determined that for most borrowers, total monthly debt payments should not exceed 36% of gross monthly income.

2. Type of product purchased

A rule of thumb espoused by many financial advisors is that debt used to purchase products that have the opportunity to increase in value is good debt. Examples that fall under this category include houses, traditional investments such as stocks and bonds, and business assets. A slight variation on this philosophy widens the category to include any purchase that has the potential to improve your financial position. A college education is the often-cited purchase in this expanded category. By contrast, products such as cars, clothing, and furniture typically depreciate dramatically as soon as they are purchased. For purchases such as these, it is best to pay cash when possible.

3. Borrowing costs

While it may seem obvious to seek out the lowest-interest rate when borrowing money, the interest rate of a particular debt instrument also functions as an effective indicator of good debt versus bad debt. Interest rates tend to be higher on debt used to purchase assets that decrease in value than on debt used to purchase assets that increase in value. Consider the disparity in interest rates between a mortgage (typically around 5%) and a department store credit card (often over 20%). Avoiding higher-interest debt will help you avoid bad debt.

In addition to interest rate, the tax consequences related to the type of interest paid should also be considered. Certain types of interest are tax deductible and can therefore lower your total borrowing costs. Examples of tax-deductible interest includes most mortgage interest, interest paid on debt used to purchase investments, and interest related to a trade or business. The deductibility and low-interest rates afforded to home equity loans makes these loans an attractive way to refinance high-interest bad debt.



	Sales Tax - Rental Property Life Insurance Good Debt vs. Bad Debt Difference Between a Will and Living Trust Tax Freedom Day Small Business/ Self-Employed Individuals Retirement Options Establishing a Financial Safety Net Financial Tips 2010 Tax Relief Act for Individuals Tips for Starting Your Own Business Tips for Small Business / Self-Employed Individuals Archived Video Tips	GOOD DEBT VS. BAD DEBT Opinions regarding the appropriate use of debt are many and varied. Some financial advisors suggest that debt is harmful in all instances while others suggest acquiring as much debt as possible, so long as it is used in a particular way. While making sense of many, often conflicting, viewpoints may prove challenging, what is clear is that there are several fundamental considerations when attempting to discern good debt from bad. 1. Total debt load The first and most important consideration related to debt is whether you can afford the payments. Based on their research and experience over many years of lending, mortgage companies have determined that for most borrowers, total monthly debt payments should not exceed 36% of gross monthly income. 2. Type of product purchased A rule of thumb espoused by many financial advisors is that debt used to purchase products that have the opportunity to increase in value is good debt. Examples that fall under this category include houses, traditional investments such as stocks and bonds, and business assets. A slight variation on this philosophy widens the category to include any purchase that has the potential to improve your financial position. A college education is the often-cited purchase in this expanded category. By contrast, products such as cars, clothing, and furniture typically depreciate dramatically as soon as they are purchased. For purchases such as these, it is best to pay cash when possible. 3. Borrowing costs While it may seem obvious to seek out the lowest-interest rate when borrowing money, the interest rate of a particular debt instrument also functions as an effective indicator of good debt versus bad debt. Interest rates tend to be higher on debt used to purchase assets that decrease in value than on debt used to purchase assets that increase in value. Consider the disparity in interest rates between a mortgage (typically around 5%) and a department store credit card (often over 20%). Avoiding higher-interest debt will help you avoid bad debt. In addition to interest rate, the tax consequences related to the type of interest paid should also be considered. Certain types of interest are tax deductible and can therefore lower your total borrowing costs. Examples of tax-deductible interest includes most mortgage interest, interest paid on debt used to purchase investments, and interest related to a trade or business. The deductibility and low-interest rates afforded to home equity loans makes these loans an attractive way to refinance high-interest bad debt.