Good Debt vs Bad Debt

Not all debt is necessarily bad; particularly when it can help you build wealth. Experts encourage consumers to know the difference between good debt and bad debt. General rules of thumb may help sort the good from the bad.

If you buy something that immediately goes down in value, that's considered bad debt. Let's say you buy disposable items or durable goods with a high-interest credit card and you don't pay the balance in full when the bill arrives. You're being charged interest while that item continues to depreciate and lose value, so that's bad debt.

On the other hand, investment debts that create value, such as real estate loans and home mortgages (which may also be tax deductible), as well as business loans and student loans are examples of good debt. Debts that produce more wealth in the long run, like high-return stocks, bonds, and other investments, are also considered good debt.

What about taking on more debt to reduce current debt? A home equity loan at 6 percent is considered good debt if you can use it to pay off a credit card with an interest rate of, say, 17 percent. Additionally, interest paid on a home equity loan is often tax deductible. Of course, the key is not to run those debts back up.

What about auto loans? You might think they're always bad debt because most cars go down in value, but if you take out an auto loan for a car that gets better gas mileage than your old vehicle, you could be better off financially.

What's the best type of debt? The number one example of good debt is mortgage debt because most homes will appreciate in value over time. 

Other strategies for building wealth include:

• Set smart goals (specific, measurable, adjustable, realistic and time-oriented).
• Pay yourself first, and automate your savings using payroll deductions.
• Understand basic investing principles, such as compound interest, risk, diversification, dollar-cost averaging and asset allocation.
• Reduce debt. Start by paying off high-interest credit card debt, and avoid late fees. Paying your bills on time makes up about 35 percent of your credit score.

If you have any further questions about debt or would like to speak to a financial service representative, contact San Diego County Credit Union at 877-732-2848 or visit sdccu.com.