Have you heard someone say, “debt is fine as long as it’s ‘good’ debt?” The idea of good debt is defined as using debt to purchase something that will appreciate in value. Some view it as a tool that helps you meet your goals faster and more easily. Here are four common sources of ‘good’ debt and how these debts can actually turn bad.
Paying cash for a home is very difficult, so the majority of homeowners have used mortgages to help them fulfill their dreams of owning a home. Responsible borrowing can be a great tool, but these foolish uses of debt can turn that home loan into a nightmare.
- Buying a home that’s beyond your budget. This is known as becoming ‘house poor.’ Struggling just to make a house payment can be dangerous and put you into a tight financial situation.
- Borrowing extra to upgrade your home or remodel rooms. Yes, remodeling your home can increase the value, but you never want to get upside down because of ‘extra features’ you thought would increase the value.
- Taking a second mortgage or refinancing to pay down credit card debt. This doesn’t solve the root of the problem – which is the inability to properly manage credit cards. This move can often put you further behind as the credit cards start to build again and the extra mortgage payment restricts monthly cash flow.
Using school loans is oftentimes necessary for students to obtain a college degree. Being conservative with these loans will help with managing the payments. Beware of foolish practices like these:
- Using extra loans to eat out and live beyond your means. You can live like a student now, or live like a student later as you struggle to repay the extra loans you took to eat out every weekend.
- Purchasing vehicles with student loans. Transportation may be a necessity, but buying a car with student loans isn’t the most prudent thing to do. Instead, save up for an affordable used car or use public transit to commute for a few years.
- Not planning for repayment. If you are studying to work in the nonprofit sector, racking up $80,000 in debt will put you in a world of hurt. Project the payments for your school loans and don’t overvalue your hopeful industry’s salary range.
Small business loans can be a great jumpstart for your business, but these factors may have you thinking twice before getting into ‘good’ debt for your business.
- Research thoroughly before borrowing. Before you begin any business, make sure you’ve done your research to see if your venture will thrive. Failing to do careful research can result in a failed business and financial troubles if you borrowed to start the business.
- Restricting terms can be challenging. Business loans are often locked into a term and many don’t allow for restructuring. If you are struggling as a business, the lack of flexibility may have negative consequences.
- Increased interest rates. The interest rates on small business loans can be higher than home and auto loans, so weigh this carefully before you commit to this kind of debt.
Real Estate Loans
Investing in real estate beyond your primary residency can be a risky, yet rewarding business. The following risks can turn this good debt into a bad investment, so proceed with caution when considering a loan for real estate investments.
- Uncertain market conditions make investing in this industry even riskier. Not understanding the economic factors involved with real estate could make your investment a poor choice and turn that good debt into a big regret.
- Repairs can be costly. Maintenance on real estate properties can get expensive, especially if you’re not a handy-person. Small repairs can add up and using a line of credit or more loans can make the situation even worse.
Yes, debt can be a good tool to help you succeed in business and to grow your investments. However, calling these four types of debt ‘good’ all the time isn’t smart. Every debt situation should be approached with caution, because ‘good’ debt can turn bad quickly if it’s used improperly.
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