Good Debt and Bad Debt: Know the Difference

Is it just a difference between personality types, or is there something else on a deeper level? Actually, the answer lurks in the fact that there are, essentially, two kinds of debt: good and bad. Sure, those are general categories, and there are values on the scale in between both extremes. But it helps to categorize what you owe by whether the indebtedness is helping you or hurting you. How can you tell? By evaluating all your loans on a case-by-case basis. That might sound like a time- consuming, complex task, but it's not. Here's a quick way to find out where you stand. It's based on simply reviewing your accounts one-by-one and determining whether your obligations are closer to the bad or good side of the spectrum.

Bad: Overuse of Credit Cards

This one's easy to detect. The sign that you're veering toward the dark side is if you have multiple pieces of plastic in your wallet and are using more than 30 percent of the allowed balances, in total. Besides your total percentage of use, take a look at the amount of interest you pay each month in total. If it's anything greater than an insignificant amount, you're leaning toward irresponsible card use.

Good: Student Loans

In most cases, student loan debt represents a very good value. You can receive an education, an intangible asset that can never be taken from you, in exchange for a certain amount of indebtedness. While there are certainly methods to paying for higher education, private student loans can be at the top of the list due to a favorable interest rate and terms. After graduation, your goal should be to have just one loan, something you can achieve via a refinancing agreement if you need to combine multiple payments. The idea behind student loan refinance arrangements is twofold: simplification and less expense. Instead of making, say, a half-dozen monthly payments on separate loans with varying rates, a refi lets you combine everything under one, organized, easy-to-track agreement. An added benefit for many who take advantage of refinancing is more competitive interest rates and better terms, especially if your credit has improved since graduation day.

Bad: Borrowing for Shady Reasons

If you need money for questionable activities like gambling, shady investments, and can't miss opportunities you heard about from a friend, you're almost certainly on the wrong side of the debt equation. Never borrow to gamble or get involved with borderline illegal deals. Likewise, never chase after stock tips or opportunities that seem too good to be true.

Good and Bad: Mortgages

For the vast majority of adults, especially those who have families, mortgages are a fact of life. Few can afford to pay cash for a house. But mortgages, like vehicle loans, come in a variety of sizes, shapes, and styles. You'll usually be on solid financial ground if you work with a licensed real estate agent, a

reputable lender, and are careful not to buy too much house, as the real estate industry likes to express it. What is too much? Check financial industry guidelines about income, debt, down payments, employment requirements, and other rules for getting a mortgage in your area. If you just barely qualify, and seem to be on the borderline in two or more categories, you might be getting into a situation you'll regret. Consider working with a financial counselor during the process to make sure you don't veer into a home loan that could end up haunting you for years to come.

Good: A Car Loan for the Right Reasons

Vehicle loans are like miniature versions of mortgages in many ways. They can help you build your credit and give you the chance to purchase a car you truly need. Or, they can be high-interest money pits that financially drain you and end up hurting your credit when you begin to miss payments. This is another situation where it helps to work with a consumer credit counselor, trusted banker, or financial planner.

Good: Strategic Use of Credit Cards

Keeping credit card use well below 30 percent of limits, preferably around the 10 percent mark, making on-time payments every month, and paying balances down in the same month you use the card for an emergency are smart, beneficial ways to use the plastic rectangles.