At first glance, the words “good” and “debt” don’t seem to be a symbiotic match, but there are indeed some instances where creating debt does generate a surplus of income or personal wealth. There are certain schools of thought that agree if a debt is going to increase your potential for income, it could be a good opportunity. However, many people don’t stop and think before they agree to take on a new financial responsibility. If you’re currently considering obtaining a debt to help get you through a specific situation you may want to keep these following advice in mind.
Always Question Your Motives
A good rule of thumb to follow when considering creating a debt is to ask yourself the following question.
“How is borrowing this money going to help me make money or get me out of debt?”
If you’re using credit to do your basic living, you’re not helping yourself pay down your debt, or even create new income. You may feel temporarily relieved, but in actuality you’re increasing your debt and just pushing off the inevitable need to pay until another day. If you approach debt from the perspective of using it help you create wealth, you’ll have a much healthier personal financial situation.
So, in short, if your motive is to create more debt, it’s not a good idea to keep digging yourself into a hole. However, if you are using the debt to increase your opportunities to generate more or new income, it may be the right move for you.
Determine What Is A Good Debt
An easy way to decide what a good debt for you would be is to determine to what degree that debt will increase your wellbeing or expand your potential financial growth. For some ideas, consider these five scenarios for creating good debt:
- Take out a loan to start a side business or to expand your current business. However, you’ll want to get the loan in your business’s name as soon as possible so that your liabilities are divided.
- Get a college education.
- Take a class or learn a skill that will help you be more employable. This can be anything from going to therapy to becoming a better communicator or even taking a sewing class so that you can sell your creations on Etsy.
- Consider getting a consolidation loan with lower interest rates.
- Buying a home or some other investment that is going to increase in value is also good debt, albeit with a bit of risk. Before you buy a home, you have to think worst-case-scenario: If this home never increases in value, can I always afford the payment?
Investing in Your Family
It isn’t a traditional approach to personal finance or debt to consider investing in your family, however, while it may not increase your revenue stream directly, it does increase the overall quality of your life and the future of your family. The main factor to consider before you agree to the debt is to honestly answer, “Can you afford to pay it back?”
If you don’t have solid proof that you can pay it back, it would not be financial prudent to consider it a good debt. The key here is establishing solid proof that you can pay it off. Many people have a feeling they can pay it back, but don’t run the numbers to determine whether that feeling is based on fact. To establish proof, you need to know exactly what you need to live on each month and exactly what income is coming in. If you have enough left over to cover the new debt comfortably, than it might be something of value to consider. Some examples of investing in your family include:
- Investing in your family’s future by sending your kids to college.
- Hiring a tutor for your children.
- Sending your overworked spouse on a vacation to relive their stress.
- Buying a home that your family is going to live in forever might be good debt even if it’s a seller’s market and the home is likely to lose value.
When it comes right down to do it, life is a balancing act. Some people preach that you should never use credit unless it can increase your income. All other debt is bad debt. That isn’t always the case, and you can’t live your life by absolutes. There are some times in life when you will need to use credit and pay interest for things that will increase you or your family’s well-being. The trick is in making educated financial decisions and balancing the risk of the debt versus the opportunities it will create.
How have you used debt to increase your wealth or help your family? Share your stories below!
For a lot of people, living with credit card debt is simply a way of life. We have all heard of the credit crunch where banks lent more to people than they could afford to pay back. When people fell behind on their repayments, the banks were in trouble and drastically cut back on the amount of money they were lending. This then led to a collapse in the housing market as a glut of foreclosures suddenly came up for sale. A lot of people, during this depression, decided that credit was actually a bad thing and they started to live a debt free lifestyle. While this is a great idea in principle, it is not a good idea to close your credit card accounts and attempt to live life on a cash only basis.
The problem is that your credit score affects many areas of your life. For example, car insurance companies now use credit scoring as a way to determine how responsible you are behind the wheel of a car. More and more companies are now using credit scoring to decide how responsible you will be as an employee. Also, if you ever need cash in an emergency, it is essential to have a good credit score to ensure you get the money you need quickly and at the best rate.
What most people do not understand is that not having credit is just as bad as having bad credit. We no longer live in a society where you can be good friends with your bank manager and he, knowing who you are and how you live, can decide whether to lend you the money you need. Most bank managers know little more than sales department managers.
At US Bank, for example, the local branch no longer has control over whether a check that overdrafts your account will be paid or bounced. If you call the branch and ask them to pay it, they will tell you that they have no control over it. They will tell you, however, that you should apply for overdraft protection so that it does not happen again, and they will happily help you fill out an application. Of course, whether or not they grant you overdraft protection depends on your credit score.
The problem with not having credit is that the credit bureaus will no longer be able to assess your credit worthiness. Rather than assume you are a good person to lend to and risk being wrong, they will err on the side of caution and assign you a poor credit score. This could lead to higher rates on your car insurance, mortgage or even stop you from getting a job or promotion.
Unfortunately, it is not a good idea to simply put the credit cards into a drawer and never use them either. A lot of companies will declare unused cards as inactive and therefore they will not count towards building your credit score. However, there is a solution that will not cost you extra money in interest and will still build your credit score.
The solution is to have between three and five credit cards and set them up to automatically pay one monthly bill each. For example, your cable bill could be paid out of one card, your car insurance could be paid out of another and your gym membership could be paid out of a third card. In order to avoid interest charges, you could then set up an automatic payment to these cards from your bank.
In essence, using this method, your money leaves your bank and arrives at the place it needs to get to; it just passes through your credit card accounts on the way. This allows you to essentially live debt free, but give you the benefits of a healthy credit score so you have access to the cash you need in case of an emergency.
Good Debt / Bad Debt: The Second Inappropriate Use of Credit
Last week, I introduced the discussion of good debt versus bad debt by explaining the worst use of credit out there: using credit to dig yourself out of debt when you do not have a budget that proves the loan will solve your financial problems.
Today, we talk about the second inappropriate use of credit: retail therapy. In the good debt/bad debt debate, this one is a no-brainer.
Good Debt / Bad Debt, Inappropriate Use of Credit #2: Retail Therapy
If you use your credit cards to buy things because you are bored or depressed, you are creating bad debt. Retail therapy makes you feel worse in the long run, particularly if you are maxing out your credit cards to finance the shopping spree. Not only is this expensive, it also hurts your credit card score. Find less expensive and more effective means of coping.
Here is a list of things you can do that will actually make you feel better and preserve your credit score. And you will notice that none of them cost a single penny:
- Invite your friends over to play card games.
- Snuggle in for movie night with a carton of ice cream.
- Write a letter to someone you love.
- Invite an old friend for a bike ride, run, or picnic in the park.
- Re-read a favorite book.
- Call your best friend with the goal of making her laugh so hard she gasps for breath.
- Take your kids to the park for a play date.
- Take a couple of hours to start that project you have been postponing.
- Wash your car, give your dog a bath, or clean out your closet. These might not seem fun, but I guarantee you will feel much more productive after conquering a chore than you will after a day of abusing your credit cards.
If these suggestions don’t work, at least make a commitment to use cash to finance your retail therapy. Sell some of those old clothes you found when you cleaned out your closet online. Then use the cash you earn from your online sales to pay for your shopping spree.