Good Debt vs. Bad Debt
Carmen’s focus on Monday’s show was sustainability. That is, building wealth that sticks around no matter what’s happening in the economy or market. Part of having sustainable wealth is knowing the difference between good debt and bad debt.
Good debt is debt that works for you to build your money, whether it’s your income or your net worth. It includes the right mortgage and the right student loans, Carmen said. Bad debt, on the other hand, detracts from your ability to grow – and sustain – your money.
Credit.com’s John Ulzheimer, On the Money’s resident credit expert, explained how good debt and bad debt play out in terms of your credit score and report.
Installment debt, which is a fixed payment for a fixed period of time, is a statistically less risky form of debt, Ulzheimer said. That’s because installment debt is generally secured by an asset such as a car or home. There’s something to lose when you don’t make a payment.
Revolving debt, which typically comes from credit cards, differs from installment debt in that you pay a different amount based on a changing balance. Revolving debt is looked upon as riskier, according to Ulzheimer and also tends to come with a higher interest rate. This is the type of debt you should be paying off first, Ulzheimer said.
A HELOC, however, is a hybrid between installment and revolving debt. It is secured by a piece of property but acts as a credit card tied to the value of that property. When the Fed lowers interest rates, your HELOC payments will go down if it’s an adjustable rate. But when the Fed hikes rates, your payments will go up.
Bottom line? Good debt (installment debt) works for you to build your money while bad debt (revolving debt) hurts your sustainability. Know the difference.
If you have a question about good debt vs. bad debt or anything else related to credit and debt, John Ulzheimer will be in our Forums all this week. Drop in and ask him a question by clicking here. Not a member? Sign up here. It’s free and it only takes a minute.