When it comes to debt in America, credit card debt often takes the spotlight with high interest rates and a large percentage of cardholders carrying a balance month to month. However, not all debt is created equal. Some types of debt can actually be beneficial if managed wisely.
I spoke with two financial experts to get their insights on how to use debt to improve your financial situation. Here’s what they had to say.
Bankrate’s take: With responsible use, good debt can help you build credit and invest in an asset or your net worth.
Exploring the Concept of Good Debt versus Bad Debt
While some financial advisors may view all debt as negative, others see it as a tool that can either increase or decrease your overall value. Monique White, from Self Financial, Inc., defines good debt as debt that has the potential to enhance your net worth and financial situation in the long term. Examples of good debt include mortgages, business loans, and student loans.
White emphasizes that credit is a tool that, when used wisely, can be beneficial. Instead of labeling debt as good or bad, understanding how to leverage it to your advantage is key.
Debt used for non-essential or depreciating expenses may not add value over time. On the other hand, certain types of debt can be viewed as an investment in your financial future.
Good debt can be viewed as an investment into your financial future.
— Monique White, Head of community at Self Financial, Inc.
Head of community at Self Financial, Inc.
3 Strategies to Leverage Debt for Financial Growth
Before taking on new debt, it’s crucial to assess the potential benefits. If the following advantages are achievable, it may be a sound financial decision. However, if the debt could lead to unpaid balances, high interest rates, or diminishing assets, it may not be the right choice.
Here are three indicators of beneficial debt.
1. Enhancing Your Credit Profile
Building strong credit involves responsible credit usage, timely payments, and maintaining a low credit utilization ratio. A good credit score opens doors to favorable loan terms and top-tier credit card offers.
According to White, credit forms the foundation of your financial well-being. A healthy credit score enables you to achieve major life milestones such as home ownership and access to premium credit products.
Good debt can positively impact your credit score by showcasing responsible credit management and repayment habits. However, it’s essential to avoid poor credit practices that can harm your score, even with beneficial debt.
2. Investing in Appreciating Assets
Debt used to acquire assets that appreciate in value can be classified as good debt. Ryan Moore, a financial advisor, explains that if debt is utilized for investments or wealth creation, it can be beneficial.
For instance, a home purchased with a mortgage instantly adds real estate value. Similarly, investing in a revenue-generating business not only boosts net worth but also creates an income stream to repay debt and increase wealth.
While taking out a mortgage or business loan can be a strategic move, ensuring affordability of monthly payments and interest rates is essential. The potential value of the asset should outweigh the cost of the debt, considering potential fluctuations in value.
3. Enhancing Your Net Worth
Investing in personal development can translate into wealth accumulation. Using borrowed funds to expand your portfolio can elevate your net worth, benefiting both you and the financial institution.
Examples include funding educational pursuits, certifications, or skill enhancements to advance your career and increase your net worth. In this scenario, you become the appreciating asset.
Student loans can qualify as good debt if they lead to sufficient income for repayment. Responsibly utilizing a student credit card for daily expenses during education is another example of beneficial credit usage.
The Key Takeaway
Debt shouldn’t carry a negative connotation. When managed effectively, good debt can boost your credit score and add long-term value, such as investing in a home or education. Prior to committing to debt, evaluate the potential gains versus losses to make an informed decision.
Moore advises that using income to repay debt on depreciating assets results in wealth depletion over time. Before pursuing new debt, weigh the potential benefits against the risks involved.