The following is a contribution from Al Krulick pf Debt.org.
Debt is incurred when we borrow money we don’t have right now in order to pay for things that we want but can’t afford. Why do we borrow funds in the present? Because we make the promise to repay our lender back, plus interest, sometime in the future.
For most of us, debt is a necessary part of life because it allows us to buy goods and services without actually having the necessary assets to support those purchases with funds from our own bank accounts.
In this sense, all debt is the same — it is simply the process of borrowing money with the expectation that it will be repaid. But in reality, debts can have either positive or negative consequences on our finances, our personal lives and our future financial worth.
As a general rule, a good debt is one that increases your net worth and helps you generate future value.
Good debts include taking out a mortgage to buy a home, purchasing items that save you time or money in the long run like an economical and fuel efficient car, or investing in your financial future by getting a college education or other type of professional training.
Borrowing money to weatherize your home is another example of a good debt. That’s a great way to save money on utility bills, while increasing the value of your house when you decide to sell it. Every homeowner hopes that improvements on their home will help them recoup the costs involved in that upgrade.
In contrast, a bad debt is one that does not increase wealth or is used to purchase goods or services that have no lasting value and may not even be needed.
Buying a major appliance like a giant, flat-screen TV with a high interest credit card is a bad debt if you cannot afford to make the monthly minimum payment. As your interest charges accrue over time, the price of the TV continues to increase. While making your credit card company richer, you only become poorer.
You can probably categorize most impulsive high-priced purchases as bad decisions that constitute a bad debt.
While there is nothing inherently wrong with buying an unnecessary item from time to time, these types of bad debts that surpass your income or your ability to make timely payments for them can put you in a very precarious financial condition.
Most of us have a combination of these two kinds of debts. But in order to remain financially stable, we should attempt to decrease the number of bad debts we have accumulated and only try to have good debts on our ledgers.
Al Krulick is an award-winning journalist with dozens of years of writing experience. He writes and blogs for Debt.org.