Finance

The Difference Between Good and Bad Debt?

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When you heard the word “debt,” what’s comes first in your mind? Is it good or bad?

Isn’t all debts are considered bad?

Though it is always better to stay debt-free, some debts can be considered as good. What does it mean?

It is an investment that generates long-term commitment in terms of income or value. This kind of debt is often called “good debt.” For instance, a student loan is another kind of good debt. Because it is used as an investment in your future, and you are obligated to give it back using the education you achieved.

Another one is the mortgage.

A home loan or also known as a mortgage, you have the opportunity to increase the current value of your property over time by adding some improvements and acquire money if you decide to sell it in the future.

While on the other hand, bad debt doesn’t increase any of your net worth or value that you bought using these lo

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ans. It doesn’t have any future value, and you don’t have any money to pay for it. Examples of these are credit cards, store credit cards, auto loans, and personal loans.

How Much Debt is Too Much?

Any amount of debts is considered too much, but sometimes it’s highly advisable to take the less evil amount. You can identify it if you’re currently living within your affordability, you can use a debt-to-income formula for that.

The formula is:

Monthly debt payments over gross monthly income equal to the percent of DTI.

To identify your debt-to-income ratio, you should add all your monthly debt payments, and have it divided by the total of your monthly gross income. Preferably, your debt-to-income rate should fall below 10-15%. And anything that would fall over 43% is considered a red flag to any creditors. It means that you are living more than what you can afford.

How to Get Rid of Bad Debt?

Getting rid of it can be quite tricky, especially if you’re living more than what you can afford to pay. But don’t fret, there’s a solution for that. There are things that you can do to minimize and manage your debts.

Manage your bills by paying off secured debts, such as auto loans and mortgages. Then clear off unsecured debts such as child support, taxes, and student loans. Next, clear off other unsecured debts that will generate from your credit card report. And lastly, all unsecured debts that are lesser compared to others will go into collections.

But remember, there are Debt Collection Agency that doesn’t bother even with smaller amounts because there are debt collectors, who specialize in collecting smaller debts.

There’s no guarantee that a debt will go to collections, so it is highly recommended to pay the money that you owe. Also, make sure that you don’t miss any payments that are automatically set up to go through your bank or creditor’s account because they will deduct it right away according to its due date.

Following these strategies will surely help you to pay all of your debts in advance, and you will not need to worry about missing payments that could affect your credit score.