Debt: how can it be good and bad?
It's almost impossible to live without some kind of debt these days unless you can buy your house in cash or your car in cash or even your education in cash. Debt is the tool to HELP you build credit, and if you use debt wisely, it can actually get you way ahead in the long run! Yes, you heard me right. Your credit score determines your future and by managing your 'good debt' effectively, you will in turn have a great credit score. This credit score will help you when it comes time to buying that first car, getting your first job, renting an apartment and even getting car insurance!
My fellow Spokester, Jill Blaney from Young & Free Alberta laid down some basics about debt. First off, bad debt is spent on things like impulse purchases that quickly lose their value and do not equate to long-terms assets. The general rule to avoid bad debt is: If you can't afford it and you don't need it, don't buy it.
The Three C's
So what about 'good debt'? Good debt is an investment that will grow in value or generate long-term income and can be summarized into what is called the 'Three C's' - credit card, car and casa! I also like to put education into the list outside of the Three C's because by investing in your education, you increase your value as an employee while also raising your potential future income!
1. Credit card
It’s true, people get into trouble with their credit card. They treat it like free money when in fact the smart way to look at it is a convenience. The term "bad debt" comes in when discussing the purchase of disposable items or durable goods using high-interest credit cards and not paying the balance in full. For example, you may love to shop for a deal; however, when you put that gorgeous blouse or awesome gadget on your credit card that was originally 40% off and carry the balance for three months, that 40% off will become close to a 100% on and you may end up paying double for that deal! That's when credit cards = bad debt. A big no-no.
Many people like to use their debit card instead of committing to the other plastic card. I mean, debit cards are great if you don't like carrying cash — but it doesn’t help you build credit. Think of that plastic card as a great way to track expenses. Things like gas for your car. You’ve budgeted for it (the money is in your checking account) so you put it all on your credit card and then when the bill comes, BAM! You pay it off. That’s a smart way to build credit.
Also, a credit card comes in real handy if you go on vacation. Renting a car or paying for a hotel room with a debit card is a nightmare. They can place huge holds on your money while you’re vacationing, which can cut into your fun.
Unless you live in a big city where public transportation is affordable and accessible, you’re going to need a car. Parents used to say, “A car is never an investment; it’s pure expense so don’t go into it thinking you’ll ever make money on the thing.” Don’t you hate it when your rentals are right? The best new car you can buy is a used car that is still under warranty while putting at least 20% for a down payment. That is good debt.
A home loan is a debt the majority of Americans will have to get in their lifetime. And it's good debt. You can deduct the interest on your taxes (legal disclaimer, I'm not a tax accountant and rules may change). In normal markets your home gains value over time— this is called equity. Don’t use the last five years as a great example of that, but things are bouncing back. And let’s face it, owning a home is a smarter use of your money than paying rent.
A word of caution
Don't take on financial burdens if you can't pay them back. Even if it is considered one of the 'Three C's' of good debt. Before you sign yourself up with good debt that will increase your credit score and help you with your long-term financial future, have a good payment plan and strategy mapped out. Without a plan, debt can be the single thing that will destroy your financial health, no matter how good you are at every other aspect of managing your wallet.