On the surface, there's no such thing as good debt. After all, when you have debt of any kind, it means that a chunk of your hard-earned income must go out each month to repay that debt when that money could be put to much better use in savings and investments. That being said, some debt is definitely considered better than other debt based on different factors that come into play in the long-term. Here we will explore some of the most common types of good debt.
The good debt benefits of taking out a school loan are twofold. One, by taking out loans to earn a degree you are improving your job prospects and income potential in the long-term. The U.S. Bureau of Labor Statistics has long chronicled the fact that those who hold degrees have lower rates of unemployment on average and higher incomes on average than those who don't. Sure, not everyone with a degree is rolling in the dough, but they are definitely opening doors for themselves that would have remained closed without a college education.
Two, school loans are considered good debt because the interest rates are generally low. This is especially true of federal loans, which have fixed interest rates (the interest rate is fixed at 6.8 percent for most new federal loans). If you can't get all of your tuition covered with a federal loan, even loans available through major banks are offered at low interest.
A home loan is good debt because a home represents an investment. For one, home ownership gets couples and individuals out of the cycle of throwing their money away each month on rent payments. Of course, whether or not your home loan is good debt can hinge on how you prepare for it. It's important to have maintained a good credit score, to have maintained steady work with a steady income for a few years, carry a low amount of overall debt, and to have saved up a sizeable down payment to get the best terms on a home loan (and most importantly, a lower interest rate).
When well-maintained and improved, homes can increase in value, contributing to one's overall financial health. Couples and individuals sometimes have the option to sell the home for more than they paid, which is why it's wise to be strategic about where and when you decide to purchase a home. Homes can also be used wisely as rental properties, where homeowners have a means of recouping some of the money they send out each month in debt repayment.
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A car payment is good debt, but only in the sense that it's a necessary evil. The biggest frustration among those taking out car loans is that a vehicle depreciates significantly the moment the buyer drives it off the car lot. Tack on the fact that by the time you pay off the loan, the vehicle will undoubtedly start needing expensive routine repairs. However, you've got to get from Point A to Point B, and most Americans don't have a lump sum lying around to pay for a car 100 percent in cash.
The good thing about car loans is that they are useful for building credit, provided you can afford the monthly payment. You can also prepare yourself for taking on a car loan by saving up a sizeable down payment, buying used instead of new, and focusing your energies on negotiating a lower interest rate, rather than focusing your energies on negotiating a lower monthly payment.
The Bottom Line
When lenders and credit agencies look at your level of debt, they look much more favorably on “good” debt, such as home, school and auto loans. High-interest credit card debt is the worst type of debt to carry, and should be avoided at all costs. When focusing on reducing your overall debt and building your credit, focus your energies first on paying off bad debt or debt accumulated by the purchase of items of no long-term value.
This guest post is contributed by Tim Handorf, who writes on the topics of online colleges. Tim is not endorsed or affiliated with LPL Financial.