What is the difference between good and bad debt?
Not all debt is created equal; “bad debt” doesn’t provide any growth value, accumulates high interest — and can take years to pay off.
The word “debt” often makes people wince; no one wants to be in debt. But there is a difference between good and bad debt. Debt that helps you acquire an appreciating asset like a home or further your life, like student loans, is generally considered good debt.
But one type of debt is always considered bad debt and gets people in more trouble than it should — credit card debt. Here’s why:
1. It comes with a high-interest rate.
Credit card debt is typically the most expensive debt that you can carry. Interest rates on credit cards are often in the double digits and can be over 20%, even for those with good credit. Cumulatively, Americans are estimated to have $986 billion in credit card debt, and it is projected to continue to increase, according to a survey by the Federal Reserve Bank of New York. Those high-interest rates can make simple purchases stick around far longer than they should.
2. Making the minimum payment will take years to pay off the entire balance.
Online bill payment makes paying your bill so much easier, but don’t forget to take a look at your credit card statement. Specifically, look at the minimum payment warning that it contains. It tells you in black and white how long — typically years — it will take you to pay off the balance in full if you only make the minimum payment. This can be very sobering (and likely makes whatever latte you purchased feel less worth it). If you have credit card debt, strive to pay much more than the minimum to save money.
3. It’s not a purchase you can build on.
A home mortgage, student loan, or business debt is typically considered good debt because these are investments that often grow over time. Additionally, these loans often have some of the lowest interest rates borrowers will have — while the assets these loans acquire are considered “appreciating assets” and will have positive returns in the long run.
Credit card debt usually accumulates through the purchase of “depreciating assets,” which include clothes, dinners, and spur-of-the-moment impulse buys. Nothing is wrong with these types of purchases, but allowing them to linger and paying high interest on them creates an unnecessary debt cycle.
Bottom line: Understand the difference between good and bad debt and that credit cards are a financial tool that can be beneficial when used correctly. It’s important not to spend more on them than you can afford and to be thoughtful about the debt you acquire. Try not to let the credit card balance grow into debt that lingers. To build strong, healthy credit, paying your card balance off each month is ideal.
Jennifer Streaks is Senior Personal Finance Reporter and Spokesperson at Business Insider and a financial contributor at The Grio. A nationally-recognized expert on money and affordable lifestyle living, Jennifer is an established financial columnist who has been featured on CNBC, Forbes, ABC, MSNBC, CBS, and more.
TheGrio is FREE on your TV via Apple TV, Amazon Fire, Roku, and Android TV. TheGrio’s Black Podcast Network is free too. Download theGrio mobile apps today! Listen to ‘Writing Black‘ with Maiysha Kai.
