How to Assess good debt from Bad Debt

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The average credit card debt in the US is in the region of $9,000. The compound interest on these debts is sometimes as high as 20%. This is an example of bad debt. A lot of this money has been spent on consumer goods, which decline in value as soon as you walk out of the shop. Good debts on the other hand are loans incurred for the purchase of goods that are likely to increase in value. Things like houses, antique furniture and stocks and shares are bought as investments. These are likely to increase in value, so if you borrow money to make the purchase, it is considered to be good debt.

You Will Need:

Paper and Pen.
A Financial Planner.

Step 1

With the help of your financial planner make a list of your good debts versus your bad debts. A rule of thumb is that if you borrow money to buy an item that decreases in value it can be considered a bad debt. When you borrow money to finance an item that is likely to increase in value, that is a good debt. Cars and consumer goods are bad debts whilst houses, student loans and investment are considered good debts.

Step 2

OK you now have a picture. All the money outstanding on your credit card at high interest is a bad debt. Your mortgage is a good debt as historically houses have over time always increased in value. Money you have borrowed to start or finance your business is a good debt because we assume the business is going to make money for you. Any student loans have been taken out because the studying and ensuing qualification will increase your income potential. This is a good debt. Your car loan is a bad debt as the vehicle will decrease in value, as will the furniture, clothes and other goods you bought on your store cards.

Step 3

What are you going to do with this information? I suggest you use it to minimalise bad debt and then use good debt to your advantage. Our parents’ generation was much cannier. My father would never buy anything unless he could pay cash, if he could not pay cash he would do without. I suggest we adopt his example for modern times. You pay cash for small ticket items like food and clothes and save the credit for expensive items like houses and antique furniture. Yes, develop a millionaire mentality and work to outsmart the interest trap.

Step 4

Let’s set about minimizing bad debt. Your car loan is a bad debt. Sell your car and replace it with a smaller model that offers exceptional gas mileage. You have now changed a bad debt into a good one! Take out a home improvement or bank loan at say 6% to pay off credit card debt at a staggering 16% (this is quite low by the way!). Again you are using debt to reduce outgoings and thus increase income. At the outset much of this will have to go to paying off bad debt.

Step 5

When you have to buy furniture, buy antiques. A few antique pieces will make your home look stylish. They will increase in value and thus constitute a good debt.

Step 6

Take out a home improvement loan to add features to your house that will increase its value. This is a good debt, but be careful you haven’t spent so much that the property is over priced in the current market.

Step 7

Use what you save in credit card payments to pay off other bad debts.

Step 8

After time you will find you have a cash surplus at the end of each month. You can save this money. Learn about the stock market or conversely learn about art or other collectibles; use your cash surplus to establish lines of good credit to buy items that are likely to increase in value.

Step 9

Use some of your money to establish good debt to study something that will enhance your earning capability. There are lots of things you can do. A good way to explore these avenues of opportunity is to go on line and look.

Tip:

Many of these suggestions are speculative. Investments can go down in value, so never commit more than you can afford. But remember this, “He who has cash is King!” You can use it to grasp opportunities as they come along.

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