What is Good Debt vs. Bad Debt?

The word “debt” tends to go hand in hand with feelings of anxiety, frustration, and of course, an empty pocket. It’s hard to argue against this when you’ve been taught to avoid debts like the plague.

But thankfully, debt isn’t always a bad thing. After all, no one is truly capable of living completely debt-free. Even millionaires have debt from credit cards, mortgages, leases, business ventures, and others.

Whether you’re riding your bike to work or being chauffeured in a private limo, there’s an important distinction between the debt that improves your financial health and one that plummets your financial health. You need to be able to separate good debt from bad debt and know how to deal with them wisely.

Even if you don't have a plan to become outrageously wealthy, the path to financial success means understanding how to manage your money, including how to leverage debts. We’ll outline the differences between good debt and bad debt and show you how to structure your finances for success below:

All About Good Debt

Good debt is defined as “an investment that will grow in value or will generate long-term income.”

The classic example of good debt is taking out a loan to fund your education. When you finance higher education or additional workplace certification, you are essentially investing in yourself to broaden your skillset.

This makes you more attractive as a potential employee. An improved knowledge base of your field will boost your abilities and help you get higher-paying jobs. The benefits of funding your education apply to a lifetime of work, making it a worthwhile investment and one of the best kinds of good debt.

Purchasing a home is another example of good debt. Sure, the bank may own the home for as long as you are still paying on a mortgage, but that monthly payment still represents ownership. It also means that in the future, you could potentially sell your home and either get your money back or turn a profit.

The important thing to remember is that good debt builds value over time. Think of it this way: if you decide to open up your own coffee shop, you’re certainly going to incur some debt as a small business owner. You will have to rent or buy a storefront, hire employees, purchase grinders or espresso machines, source coffee beans, and more.

But over time, your small business can become a huge source of income. You can use that income to pay down your debt, and when you’re ready to retire, sell your business to another owner for a nice profit. In this, there’s a value that has been built over time that will greatly benefit you.

All About Bad Debt

While good debt represents investments that increase in value over time, bad debt represents things that won’t increase in value or provide revenue in the future.

Credit cards are the most common example of bad debt. They encourage spending above your means and come with high-interest rates, increasing your overall debt. Even worse, if you are making late payments on your credit cards, you can find yourself paying penalty fees on top of your interest. Failing to make timely payments can even result in a hit on your credit score. This affects your ability to get loans and other benefits. For instance, a bad credit score can make it harder for you to get a mortgage to buy a home.

But even bad debt isn’t always black and white. For example, if you pay off your credit card on time every month, a customer reward program can turn a credit card into a valuable form of debt. You can apply the points earned to future purchases, statement credits, travel, and more.

When taken out for the wrong reasons, personal loans can become categorized as bad debt. For example, taking out a cash advance online to fund a vacation that’s otherwise not affordable is a high-interest expense that doesn’t bring long-term monetary value in return. But if you’re taking out a one-time loan to consolidate debt or even finance home improvements, then presto: that's bad debt turned good.

The key to classifying debts as bad is knowing whether it has immediate or long-term value. Will you be able to turn that debt into income in the future? Can you afford to pay that debt off in a timely fashion without accruing high interest? Are you using that debt for your greater financial good? If not, then you’re likely staring bad debt in the face.

Tips on Getting Out of Debt

If a close look at your finances reveals more bad debt than good debt, don't panic. You’re not alone. Bad debt is by and large the most common financial pitfall for thousands of Canadians. However, many have gotten past this and have now achieved financial security. The good news is that there are plenty of ways to start chipping away at your bad debt. Here are some effective tips to get you out of bad debts:

Make a List of What You Owe.

Write out the remaining balance on every credit card or loan you have. Make sure that you include the interest rate and any associated fees, too. This is the first step to understanding exactly where your financial health is at the moment and how to start to resolve it.

Use The Snowball Method.

This approach helps with maintaining order. You simply arrange your list of credit card debts from the highest balance to the lowest. Then, make the minimum payments on all cards except for the card with the lowest balance. You will need to make double payments on the card with the lowest balance. Once that card is paid off, you take that same payment amount on the next lowest card, repeating until all your credit cards are successfully paid off.

Consolidate Or Refinance Your Debt

If you have a few personal loans, you can combine them to make payments easier or refinance them to get a better interest rate. And while you may not be able to combine credit card debts from one card to the next, getting a short-term loan can be a good way to pay off multiple cards at once. You also have an extra motivation to make larger, quicker payments.

Conclusion

Knowing how to handle your debts starts with understanding the differences between good debt and bad debt. Once you have this foundation, you’ll be able to cut out the ones that harm your financial wellbeing. You also need to take advantage of all the opportunities before you. For example, if a good opportunity presents itself at work, don’t hesitate to negotiate a raise with your boss.

If you want to learn more about using payday loans to consolidate your debt and give your financial health a boost, My Canada Payday is here to help you. We assist our customers in getting back on their feet and learning smart financial habits. Call (604-630-4783) or email (getpaid@mycanadapayday.com) us at any time to get in touch with our support team and find out why Canadians across the country are choosing My Canada Payday.