Some people will tell you that all debt is bad. Others will tell you that debt is necessary. The truth is somewhere in the middle. Some debts can be viewed as a form of investment, while others can have many negative repercussions. This post compares some of the best and worst types of debt.
The best types of debt
The best types of debts are those that can lead to financial returns in the future. They can be viewed as a sensible investment. There are a few common examples of this:
Mortgages
Most people cannot buy real estate without taking out a mortgage. In fact, most people would have to spend a lifetime saving up money to buy a house in cash.
Owning property gives you freedoms that renting doesn’t – like being able to make home improvements. You also have the ability to sell your home and make your money back. Given that homes tend to appreciate in value, there’s a high chance that you could even make a return when you choose to sell your property.
Of course, even if you don’t plan to ever sell your home, a mortgage can still be an investment. You’ll eventually pay it off. This is not the case when renting – you keep paying rent forever. Whoever inherits your property also has the opportunity to sell it. It could be a way of passing down some wealth to your kids.
Student loans
Student loans are also a healthy form of debt, because they enable you to obtain an education – which could be necessary to achieving a high-paid job that you enjoy. Without taking out a loan, many people cannot afford to pay for studies.
There are two different types of student loans that you can apply for in the US: federal loans and private student loans. Federal student loans often don’t require a credit check and have flexible repayment options, but not everyone is eligible for them. Private student loans do require a credit check and can have higher interest rates, however they do have the flexibility of allowing you to borrow more – which could allow you to pay for other education-related fees not covered by a federal student loan. Do your research in order to make sure that you apply for the right type of loan.
Business loans
Business loans can be a good form of debt. The startup costs of some businesses can be very high. A business loan allows you to launch your business immediately without any savings. This could allow you to quickly take advantage of a gap in the market.
Providing that your business is a success, you should be able to pay off the loan and then start making a profit. This is an example of how a loan can be turned into an income.
Take your time to shop around for business loans to get the best interest rates. Bank loans can often have lower interest fees than private lender loans.
Refinancing
Refinancing can also be viewed as a healthy form of debt. This is when you pay off a high interest loan with a lower interest loan. This can ultimately help you save money in interest fees.
There are other forms of refinancing that could also make existing debts more affordable. This could include taking out a new loan with more affordable repayments, or consolidating debt (paying off multiple debts with a single loan, so that you only have to keep track of one debt).
The worst types of debt
The worst types of debts are those that unnecessarily cost us extra money. They are typically the result of poor budgeting and toxic spending habits. A few examples are listed below:
Arrears
When you miss a bill payment, this is known as arrears. There are many reasons as to why people fall into arrears – including some forgivable reasons – however, most people get into arrears because of poor budgeting.
Why are arrears harmful? Because they negatively affect your credit score. They can also result in late payment fees. This means that when you do finally pay the bill, you have to pay an extra fee on top.
Fall behind by several payments and the creditor may call a debt collection agency to retrieve your money or you may be asked to go to court. Services are likely to be cut off, items you own could be seized and you may even get blacklisted. This makes arrears one of the worst types of debts.
Payday loans
Payday loans are short term loans that are intended to be paid back once you receive your next paycheck. They are a bad form of debt because they often have very high interest rates. Consequently, you could end up paying back double what you borrow.
These loans are designed to help pay for unplanned expenses. However, some people take out payday loans purely to accommodate for poor budgeting or to buy things they don’t need. Setting aside savings and keeping a strict budget can prevent the need for payday loans.
Gambling debt
Taking out a loan to fund a gambling habit is the very worst form of debt. When you gamble with money you’ve borrowed, there’s no guarantee that you’ll win that money back. In fact, if you lose, you’ll have put yourself in extra debt for nothing.
Of course, gambling is an addiction and it can become all too easy to chase losses. To gamble responsively, it’s key to maintain a gambling budget and never bet more than you are willing to lose.This will reduce the need for any loans.
Salary advance
A salary advance involves asking your employer to pay your wages early. This could be to cover unexpected payments.
The problem with this is that by borrowing money from your next wage, you leave yourself short next month. Unless you’re able to work extra hours or make some extra money on the side, you’ll have to survive on less money next month. It is also not always legal for employers to provide salary advances, plus they put you in debt to your employer. This is why salary advances can be a dangerous form of debt.