Personal Finance

Good Debt versus Bad Debt

You probably often hear financial experts discuss the importance of keeping bad debt low, while effectively managing good debt. In fact, creditors assess the balance of your good debt versus bad debt when determining whether or not you are a good candidate for a loan or a line of credit.

So how can you determine what is good debt or bad debt? While the answer to this question can vary to a certain extent, the following are a few different types of debt that are consider either good or bad:

What Is Good Debt?

“Good debt is investment debt that creates value; for example, student loans, real-estate loans, home mortgages and business loans,” explains Eric Gelb, author of Getting Started in Asset Allocation and CEO of Gateway Financial Advisors.

Generally, debts that are related to investments are considered ‘good debt.’ People are often surprised that debt can be considered an investment, but there are actually many different types of debt that are deemed investments.

For example:

• Buying a Home: Since houses generally go up in value over time, buying a home is actually a great investment! While it often represents most people’s largest debt, a home purchase can actually be great for your financial well-being.

• Paying for College: Attaining an advanced degree ultimately leads to higher pay, which means that while going to school may incur some debt, it eventually leads to higher income over a lifetime.

What Is Bad Debt?

While bad debt is not always avoidable, your goals should be to keep these financial obligations as much as possible. Bad debts are essentially anything that creates an unbalance in your financial health.  Consumable products, for example, are a prime example of bad debt. In many cases, people do not begin paying them off until well after the purchased item has been used or consumed.

For example:

• Credit Card Debt: Credit cards can be a useful tool – as long as you are sure to pay off the FULL balance each month. Allowing bad debt to build and only making the minimum monthly payments can lead to financial problems and a debt spiral that can last for years to come. Avoid this problem by using your credit card judiciously.

• Buying a New Car: It’s a harsh truth, but financing a new car is one of the worst financial choices you can make. In addition to losing a large portion of its value once you drive it off the lot, the impact of depreciation can mean that much of your car’s value is depleted before you even pay off the debt. If you must buy new, make a down payment of at least 20 to 30 percent of the car’s value. The best choice is to purchase a used car from a reputable dealer that is offering to certify the vehicle and provide some type of warranty.

• Paying for a Vacation on Credit: If you are planning a vacation, be sure to save money to cover your travel costs rather than putting it on credit. Never go into debt to finance a vacation. Not only will you be paying for your trip long after you return, the vacation will actually end up costing much more due to interest.

Cleaning Up the Bad Debt in Your Life

Now that you’ve learned a bit more about the differences between good debt and bad debt, make an assessment of your debt. How much good debt do you have? How much bad debt?  After sorting your debts into the two categories, start thinking about ways that you can reduce your bad debts.

One of the best ways to lower your bad debts is to set aside a specific amount of cash each month to pay off credit cards, auto loans and other bills. Some people are tempted to leverage their good debts (such as home equity) to pay off bad debts (such as credit cards). This is generally a bad idea and should be avoided. Instead, focus on paying your good debts faithfully while progressively working on lowering your bad debt. While it may take some time to accomplish, even small steps can make a big different in your overall financial health.

Debt Reduction Tools:

• What Will it Take to Pay Off My Credit Card?
• When Will You Be Debt Free?

In a move designed to revitalize the stagnant housing market, the Senate has voted to approve a measure that would provide a tax credit of up to 10% of the value of new or existing homes, with a cap of $15,000. The current law in place provides a $7,500 tax credit, but only to first time home buyers.

According to Alan Zibel, writing for the Associated Press, the credit would work as follows: People who buy a home would have 10 percent of the purchase price applied to their tax bill. What about people who owe less than that in taxes? The credit would allow home buyers to spread the tax credit out over a two year period.

Anyone who buys a home during the year would qualify. To prevent speculators from taking advantage, the law would require buyers to live in the home as their primary residence for a two-year period.

I’m currently in the market for my first home, so this sounds like great news to my ears.

Diana Olick, of CNBC, notes that the tax credit would be helpful, but certainly not a silver bullet to fix the ailing housing market.

“The tax credit, while available to all buyers, is really only going to help a first-time home buyer who has good credit and money to put down on a 30-year fixed. It won’t overcome the hurdles facing the bulk of potential buyers out there who either have to sell their current home or don’t have the good credit and downpayment necessary to take advantage of today’s low mortgage rates.

In other words, the tax credit is a good start, but let’s hope it’s not the finish.”

While most of us realize that money can’t buy happiness, we are not always aware of the unhappiness that the pursuit of money can cause. Debt, poverty and financial strife are the obvious financial culprits that contribute to money-related stress and misery, but recent research also suggests organizing our lives around achieving wealth actually decreases our overall life satisfaction.

Essentially, devoting too much time to earning more, saving more and scrimping more can increase depression, anxiety and unhappiness. According to psychologist Tim Kasser, Ph.D., people who say that their major goal is to attain more money are generally far less satisfied with their lives and experience more emotional distress. This isn’t just true of the stereotypical workaholic who never stops to smell the roses. Researchers have demonstrated similar results across many age groups and in numerous cultures.

Fortunately, it is possible to achieve financial peace of mind (and even sock away a significant nest egg) without damaging your emotional well-being.

Focus on the Positive

When you are creating your household budget, balancing your checkbook, clipping coupons or figuring out your taxes, it can be all too easy to focus on the negatives.

“I don’t earn enough money.”
“I can’t afford it.”
“We’ll never save enough for retirement.”

Negative thoughts such as these only generate more negativity. When dealing with financial matters, strive to develop a more constructive mindset. This certainly doesn’t mean overlooking money mistakes or problems. It simply means focusing on the positive steps you can take to improve your situation and make more out of what you have.

Develop a Sense of Personal Control

People who lack financial knowledge or experience often blame external forces for financial troubles. This type of thinking can make you feel powerless. No matter what your situation, it is important to assume personal responsibility for your finances. Rather than assign blame to outside influences, make a list of steps you can take to remedy the situation. Even when external events and situations hamper your ability to save money, avoid a sense of hopelessness by remembering that you have the power to control your financial destiny.

Another important step is to start learning all that you can about money, savings and personal finance. In order to develop a sense of personal control over your money, you need to know the best ways to both spend and save. Books, blogs, magazines, podcasts and television programs can all offer useful information that can help you in your pursuit of financial peace of mind.

Ignore What Popular Culture Has To Say About Wealth

Everywhere we turn it seems that we are perpetually bombarded with messages about how to achieve “the good life.” Driving an expensive car, living in a lavish home and going on extravagant vacations are often viewed as great examples of the epitome of human existence. Popular media continues to emphasize this message despite the abundance of psychological research demonstrating that these materialistic ideals may actually harm our mental well-being.

Instead of following this tired trend and struggling to “keep up with the Joneses,” start developing your own highly personal definition of what it means to be wealthy. While it is still important to eliminate debt and save money for retirement, college and medical expenses, there are many other pursuits that can make life much more satisfying. Maybe being wealthy means having great friends and a healthy family along with financial security. Think about the things that are the most important to you when coming up with your own definition.

Practice Simplicity

Learning to enjoy simplicity is a great way to stop the endless pursuit of wealth, while at the same time saving more money and getting more enjoyment out of life. Simplicity is all about eliminating unnecessary things in order to devote your time to what truly matters in life. Adding simplicity to your life might involve utilizing frugal living ideas, buying less and making better use of the resources you already have. The great thing about practicing simplicity is that it can reduce the stress and anxiety of struggling with your finances, while actually helping you to achieve greater wealth in the long run.

In a consumer-driven society, resisting the temptation to pursue wealth at all costs can be difficult, but the rewards of doing so can make your life richer and more meaningful. Fortunately, it is possible to achieve financial peace of mind without enduring too much stress, strife or anxiety. By maintaining a positive outlook, developing a sense of personal control, creating your own definition of wealth and enjoying the simple things in life, you can reach your goal of financial well-being healthily and happily.

Reader’s Digest features an inspiring article about the secrets of self-made millionaires. If you want to learn what it really takes to save a million dollars, this article offers a number of great tips.

If you imagine Wall Street power brokers and wealthy socialites living in penthouse apartments and exclusive mansions whenever you hear the word millionaire, then think again. As writer Kristyn Kusek Lewis points out, ” …many modern millionaires live in middle-class neighborhoods, work full-time and shop in discount stores like the rest of us. What motivates them isn’t material possessions but the choices that money can bring.”

The article describes five secrets of successful self-made millionaires:
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There are many ways to increase the amount of money you save each year, including cutting spending and contributing to a 401K. Another great way is to increase the amount of money you earn each year.

How? While your salary might seemed fixed, there are many different ways to boost your yearly earnings. Apply some of these top tips for how to earn more money in order to build your personal wealth and contribute more to your yearly savings.

1. Consider asking for a raise. While this might not be a viable option for all individuals, even a small increase in your hourly pay or yearly salary can make a dramatic difference. But asking for a raise involves much more than just telling your employer that you want more money. You need to make a case for why you deserve a raise. For example, explain how much you have improved sales or productivity during your tenure in your current position.

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