Understanding Good Debt vs Bad Debt

Understanding Good Debt vs Bad Debt

Reading Time: 4 mins

All things considered, time is one of the most precious resources on the planet. Even the world’s wealthiest billionaires cannot buy more time—it’s always slipping away. Throughout history, we have dealt with time scarcity by incurring debt—borrowing funds to get something without waiting to save money for it.In turn, you would have to pay the lender an interest rate on the borrowed sum—principal. To be sure, some debt is bad. Moreover, with the variety of financial products present now, it is more challenging to navigate through many types of debt. Let’s find out when to indebt yourself and with what kind of debt.

Get Approved for a Loan Up to $50,000 in Under 60 Seconds

Quickly and easily search LoanConnect’s lender network to find a competitive loan offer that best suits your needs.

Apply Now
We earn a commission if you make a purchase, at no additional cost to you.

The Difference Between Good Debt and Bad Debt

To put it simply, any debt that is spent on something that deteriorates in value over time is bad debt. On the other hand, good debt is one where you would spend your borrowed funds on something that increases in value.

  • Good debt—borrowed money to spend on assets that appreciate.
  • Bad debt—borrowed money to spend on assets that depreciate.

What is Good Debt?

Sometimes, a good debt may only superficially seem bad when based on the singular measure of appreciation vs depreciation. For instance, if you were to buy a computer on credit, that computer would drastically drop in value in just one year. However, if you used the machine to complete online education courses, gain skills, and find a new source of income, incurring that debt was a good idea.

Check your free credit score in Canada

Sign up for Borrowell to get your credit score and credit report for free!

Sign Up For Free
We earn a commission if you make a purchase, at no additional cost to you.

You should employ this tactic every time you consider borrowing money. Always ask yourself—how will this debt help me improve my life in the long-run?

Student loans

North America is notorious for its enormous student loan debts. While not as bad as in the US, Canada’s student loan debt has surpassed $22 billion, with the average student loan debt coming in at $17,000. Of course, we consider a student loan to be good debt because you are levelling up education and skills to potentially gain access to greater income.

However, be careful to select the proper course of education, one that is in demand in the marketplace. Otherwise, a student loan can quickly turn into bad debt.

Home Equity Loans

Home equity credit is very popular in Canada, with over 3 million equity loans. Otherwise known as HELOC, this debt is viewed as “good” primarily because it offers low-interest rates compared with payday loans or credit card debt. Nonetheless, borrowing money against the value of your home does represent a risk of its own, so make sure you can afford its monthly payments.

The worst thing to do is to treat home equity loans as a source of cheap cash. Instead, try to use it to open a small business, improve an existing one, or invest in blue-chip stocks with high dividend yields (5–7%) that will outpace the interest you will incur.

Mortgage

Unlike HELOCs, mortgages are loans against the value of the real estate that you are about to purchase instead of the one that you already own. Additionally, HELOCs allow you to hold the funds in reserve and withdraw them when needed, while a mortgage releases funds in one sum (ie when buying a home).

Like HELOCs, mortgages also enjoy huge popularity in Canada, with over $1.5 trillion worth of real estate assets. Without a doubt, a mortgage is a good debt because, when your debt is cleared, you’ve gained property that (likely) won’t depreciate in value. On the other hand, when you pay rent, you don’t gain any value at all—except the value of being warm and dry, of course.

What is bad debt?

You already know that even good debt can turn into bad debt if you misuse the funds. However, some lines of credit are intended for short-term consumption. Therefore, they are inherently bad as they don’t lead to an increase in value.

Credit Card Loans

Modern living is marked by the prevalence of credit cards across the globe. Anyone employed or self-employed almost certainly has a credit card. Although credit cards allow you to buy things that surpass savings alone, it is easy to fall into a credit card trap. Instead of relying on your discipline to save, this financial instrument is always there to seduce you into buying things you want right now.

To avoid the credit card trap, a mindset you should adopt is to pay off your credit card every month. Otherwise, you will find yourself with an exceedingly high-interest rate!

Payday Loans

Payday loans are the worst form of debt, the likes you would see in movies where characters end up in a never-ending debt cycle. Sadly, almost two million Canadians have incurred this debt. If you thought that credit cards have a high-interest rate, they have nothing on payday loans where your interest rate rises to triple-digit numbers!

Additionally, if it happens you are unable to repay the loan on the next payday, you will be penalized. Then, the lender can withdraw funds directly from your bank account. On top of that, penalties have the effect of lowering your credit score, especially if your debt ends up being sold to a collection agency.

Auto Loans

As far as depreciating assets go, automobiles are the worst offenders. The moment you drive one off the dealer’s lot, it declines in value—precipitously. It is hard to find any situation in which it would be smart to buy a completely new car instead of a used one. Therefore, always prioritize buying used, or in some cases leasing, instead.

How to use debt to your advantage

Nowadays, it’s almost impossible to avoid some form of debt. Outside of using your debt to improve your skill, consider levelling up your credit score as well. You will likely need to borrow for a significant expense in the future, and having a high credit score (above 650) will be critical.
Therefore, create a solid credit history to impress your future lenders. It’s not difficult—you simply pay off your credit card slightly less than your balance for a couple of months. When you have gained a credit history, use debt strategically—for example. buying real estate.

Final considerations

Life would be much harder without lenders. Unless you were born with a silver spoon in your mouth, debt is inevitable if you want to get ahead in life. However, that is the key—focus on getting ahead—instead of using debt as a convenient go to. Even if you use debt to open a small business and it eventually fails, you will learn valuable lessons you can later apply to new ventures. You’re merely borrowing against the future!


Your credit score can have a big impact on your financial future. Sign up for Borrowell to get your credit score and credit report for free! Join over a million Canadians and get the tools you need to help understand, manage, and master your credit—in under 3 minutes. Checking your credit score with Borrowell won’t hurt your score.

Share:

Money-Saving Resources

related_product_img
Why Does Your Credit Score Drop After Paying Off Debt?
related_product_img
The Pros and Cons of Personal Loans
related_product_img
7 Signs That You’re Carrying Too Much Debt
Subscribe
Notify of
guest
0 Comments
Inline Feedbacks
View all comments