Why Debt Isn’t All Bad

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Some financial experts will tell you that having any type of debt is a bad thing. After all, debt reduces your net worth, strains your cash flow and costs you extra money in interest charges.

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That said, it’s not always realistic to go through life paying cash for everything. And when done right, borrowing money can give you access to tools and opportunities that can actually lead to greater wealth down the road. That’s where the concept of “good” debt and “bad” debt come in. Let’s take a closer look at what they mean.

What Is ‘Bad’ Debt?

Bad debt is used strictly for consumption and is often a result of living above your means, according to Jason Dall’Acqua, a CFP and president and advisor at Crest Wealth Advisors

Examples of bad debt include credit cards, high-interest personal loans and payday loans. Auto loans are also usually considered bad debt because vehicles quickly depreciate in value. “These loans do not provide any upside investment potential and can lead to high interest costs over time,” Dall’Acqua said.

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What Is ‘Good’ Debt?

Good debt, Dall’Acqua explained, helps you to purchase an asset that is likely to increase in value or provide cash flow. Examples of good debt include:

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Prevent Good Debt From Going Bad

Even though a certain type of debt may be considered good, it still comes with certain risks and costs. “Good debt can often be bad debt in disguise,” said Tara Unverzagt, CFP, founder and chief advisor at South Bay Financial Partners

For example, buying a house can help grow your wealth over time, but it’s not guaranteed — especially in the short-term. Similarly, taking out a business loan without a solid plan for how you’ll use the money can result in being overleveraged.

So if you do decide to borrow money, there are some steps you should take to ensure it benefits your bottom line, according to Taylor Venanzi, CFP, owner and financial planner at Activate Wealth, LLC:

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The Bottom Line

Unverzagt emphasized that debt requires a lot of thought and understanding of what results could happen. “People like to be optimistic and only look at the bright side of the equation,” she said. “And that’s fine as long as you are prepared to deal with the downside also.”

So be sure you have a good plan when taking on debt … even if it’s good.

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