November 16, 2020Good Debt, Bad Debt – Knowing the Difference
You might be under the impression that all debt is bad, but that isn’t true. While no one likes to owe money, some loans can help you become more financially secure.
There are good debts, and there are bad debts. Good debts are not as risky to lenders and may lead to better loan terms. Bad debts raise red flags to lenders and make them more cautious about lending you money, leading to higher interest rates. To help you better understand the differences, let’s review some examples of good and bad debts.
Unsecured Debt vs. Secured Debt
Most debt falls into two categories: secured debt and unsecured debt.
Secured debt that is “secured” by collateral, like mortgages and car loans. If you do not repay the secured debt as promised, your lender can repossess the security (your house or car) to satisfy your debt and make up for some of the losses they would incur. Secured debts typically are good debts.
Unsecured debts are debts that have no collateral assigned to them, like credit cards and personal loans. They have more significant risks to lenders because there is nothing they can claim in return for your debt if you do not repay as agreed. Due to the increased risk, the interest rates are typically higher. Unsecured debts usually are bad debts, with a few exceptions.
Only use unsecured debts as needed and repay them as quickly as possible. For instance, it will serve you best to pay off your credit card balances monthly, especially since the interest rates are higher.
Good or Bad — How Can You Know the Difference?
One of the questions you should ask yourself when considering debt is “How will this impact my long-term financial health?” Bad debt typically offers temporary satisfaction and brings no real value to your long-term financial life. Good debts are debts that help you secure better positions in the world. Here are a few common examples:
- Student loans, while unsecured, can be good debts—if you complete your education and earn a profitable degree. If you earn your degree, the debt helps you secure better jobs and increase your earning potential.
- Also, a mortgage is good debt if you make your payments faithfully and on time. It is a long-term investment that will eventually lead to little or no house expenses later in life. When you’re ready, you can always see a PEFCU home loan specialist to help you take this major step.
- Auto loans, while secured, can become bad debts if the interest rate is excessive or if the loan terms are unfavorable. On the other hand, your new car can become the vehicle that takes you to a better job and a better life. At PEFCU, we will do what we can to help ensure you are approved for an auto loan that is affordable so that you can enjoy the benefits of having a reliable ride.
We’re Here to Help!
As a credit union, we’re dedicated to helping you achieve your financial goals. From providing education to extending good debt and more, we’re prepared to help you build your credit and avoid unnecessary bad debt traps. Simply stop by any branch location or give us a call at (800) 226-6673 to start your journey.
Each individual’s financial situation is unique, and readers are encouraged to contact the Credit Union when seeking financial advice on the products and services discussed. This article is for educational purposes only; the authors assume no legal responsibility for the completeness or accuracy of the contents.