Good debts vs. bad debts: learn to differentiate them

As a general rule, nobody likes debt. These are always perceived as something negative and everyone tries to run away from them. However, not all debts are the same. There are debts that impoverish us, but also others that allow us to earn money. In this article, we will help getting out of payday loan debt.

Bad debts

Bad debts arise when we decide to buy something that we can not afford to pay in cash. For example, the mortgage on the house, the car loan or the purchases with the credit card. These debts make us poorer since in practice they involve bringing money from the future that we will have to repay along with their corresponding interest.

Bad debts do not report any kind of benefit beyond the consumption of the good that we acquire with them. In short, they serve to buy liabilities, that is, things that do not offer us any economic return, but quite the opposite: they make us lose financial freedom.

If someone pays their vacation with a credit card, it is generating bad debt. The purchase of a 4K TV in 36 installments without interest but with an opening commission of 60 euros, is also a bad debt. Any consumer loan that is amortized over a period longer than the life of the financed product is a bad debt.

There are some debts that are not only bad, but they are very bad. We refer to those that have a very high APR. This type of debt is extremely dangerous since it tends to grow like a snowball if we get distracted and are not careful.

For example, very bad debts are discovered in account that some people use to finance the expenses of the last days of the month to wait for the payroll or deferred payments for a long time with credit cards.

Good debts

In contrast to bad debts, there are other debts that are considered good and that are unknown by many people. A good debt consists of borrowing money in order to acquire goods or make investments that will report a flow of money into our pocket.

With good debts assets are bought that give us a return, so they are useful to increase our wealth. Good debts also involve the payment of interest and commissions. However, the profitability that we obtain thanks to it is higher than its derived costs. Otherwise, they would be bad debt.

For example, there are people who go into debt to buy a home that later goes to rent. If the monthly payment for the mortgage is 400 euros and then rent the house for 700 euros per month, each month they get a profit of 300 euros. In this case, the debt with which they buy the house is good. We say that these people have leveraged.

In general, the purchase of any good whose value will increase with the passage of time is a good debt. The apartments near the beach, antiques and vintage vehicles are some examples. If a person goes into debt to finance an entrepreneurial project and create his own company, this is also a good debt.

However, it should be noted that good debts also involve risks. A bad investment can ruin a person. As a proof, ask those who invested in real estate back in 2007. Credit is a very useful tool to increase wealth if and only if it is used correctly and with a head. Otherwise, it could give us great displeasure.