The Dangers of Good and Bad Debt

Good and Bad Debt

If you’re like most Americans, you carry debt from month to month. It could be good debt, like a home mortgage, or it could be bad debt, like credit card balances.

Either way, debt is still you owing money to a financial institution, a credit card company, a retail store or another place.

Have too much debt to pay each month and you can find yourself circling the financial drain toward bankruptcy as interest rates compound, adding even more debt to pay.

Beware of Traps

While there are times when carrying debt is a good thing, debt in an of itself should be approached with caution and be carefully used because it can be a double-edged sword.

Debt can be good when it helps you accomplish something — improving your credit score or making money in an investment, such as buying a house.

If you are the type of consumer who uses credit cards and pays them off each month, you could possibly be improving your credit score by keeping a zero balance. However, it’s a slippery slope and others aren’t that lucky.

More than half of Americans — 56% — carried an unpaid credit card balance in the past 12 months with the average unpaid monthly balance being $3,389, according to online credit card marketplace CreditCards.com.

Credit card debt can turn bad when the balance isn’t paid down and the interest rates compound the amount and add to the balance.

Just paying the minimum on the balance each month doesn’t drop the balance — it just maintains the balance, because of the interest rates. To truly get out from under credit card debt, you would have to pay more than what the interest rate adds each month.

Good Debts Gone Bad

A home mortgage on the surface seems like good debt and can be a useful tool in getting you a home of your own. Even a mortgage can turn into bad debt if you get a mortgage amount for more than you can afford to pay each month.

Then there’s the risk of the home’s value dropping below what you paid for it — as was the case in the housing bubble crash several years ago. Even if the house’s value is lower than the mortgage, you are still responsible for the monthly mortgage payment.

Student loans are another example of potentially good debt, because they finance higher education, but they can also turn into an anchor to financially drag you down if you can’t repay them for some reason — like being unable to find a job in a weak economy.

In a perfect world, you wouldn’t need to get into debt. However, if used correctly, debt can help you attain your financial goals. Keep in mind that debt sword cuts deep and it’s something to try to steer clear of through frugal spending.

Photo Credit: Wonderlane

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