While it is possible to live completely debt-free, it isn’t easy and isn’t cessarily smart. For the average Canadian, it isn’t likely you will ever have enough money to pay cash for some of your most important, and certainly largest, purchases – a car, post-secondary education and a home. And avoiding debt at any cost will mean depleting your savings for emergencies. The challenge in acquiring debt is in understanding which debt makes sense and does not, then wisely managing the debt you have.
Bad debt
Basically, bad debt is debt that makes you poor – consumer debt. This includes debt you have acquired by purchasing things you don’t need and can’t afford.
The worst form of bad debt is credit card debt, since it usually carries the highest interest rates. If you are purchasing items with a credit card and cannot pay the entire balance by the due date, your debt will only increase.
For every month that you make a partial payment on you credit account, you are charged high interest rates, so even though the item you purchased is depreciating in value, the amount you paid for it continues to increase. The best way to avoid incurring bad debt is to avoid unnecessary purchases that you can’t pay cash for.
Good debt
Good debt is acquired when you purchase something you need but cannot afford to pay for up front without using all of your cash savings or liquidating investments. When debt makes sense, ensure you can afford the monthly payments.
Good debt is often an investment that will increase in value or will generate income in the long run. Taking out a mortgage to buy a home is considered good debt for this reason.
Home mortgagees tend to have lower interest rates than other forms of debt. And so, even though mortgages are long-term loans (often 25 years), the monthly payments are low enough to allow you to keep the rest of your income free for investments and emergencies. Ideally, your home will increase in value as you pay it off, so that you end up owning the home free and clear.
Of course, when all is said and done, it is important to adopt the motto “Everything in moderation,” especially where debt is concerned. Even good debt can have its downfalls, so be careful you don’t take on too much. If you are overloaded with debt, good or bad, it can still affect your financial well being.
Watch CBM’s blog as we continue to explore the principles of debt and give you tips to eliminate bad debt and acquire good debt in your financial portfolio.
