Many people think that going into debt is a bad thing, or that it will negatively affect your credit. But we are here to teach you that debt is not always bad. The concept of debt is the same: you receive money now and make a plan to pay it back in the future. Different situations and consequences cause that debt to be labeled as “good” or “bad.”
Good debt is money you borrow for something that could increase your net worth. But what exactly is net worth? You have probably heard someone say “Bob has a net worth of $2.5 million dollars.” Does this mean he has $2.5 million dollars sitting in a net somewhere? While that would be amazing, net worth is actually the amount you own in assets minus the liabilities you have. In other words, if you took all your possessions and sold them, then used the money to pay off your debts, the net worth is the amount you have left over.
Establish or Build Credit
Going into debt can help establish credit or build up your credit score. Certain loans and accounts are customized specifically to help credit. This would be an example of “good debt.” Here are some options:
Secured Credit Card
If you are trying to establish credit, you could get a secured credit card. You would make a deposit at the time of opening the card, which secures the debt. Then you would use the card just like a normal credit card—making payments on time, or paying interest on any balance at the end of the month. When selecting a secured credit card, make sure it has these options:
- Reporting to all 3 credit bureaus: Experian, Equifax, TransUnion
- Low Annual Fees
- Convenient Payment Options
Secured Savings or Secured Loan
Similar to the secured credit card, you would make a deposit to open the account. The difference is the lender holds the funds in the account until the loan is paid back. You would make your payments until the loan in paid in full, then the lender would release the funds. As you make regular payments on your loan, your credit is built and you only pay interest on the rate difference between your savings and the loan. Ascent Credit Union offers Secured Share or Secured CD Loans. Click for more information or to apply.
Get a loan with a Co-Signer
You can obtain a loan with someone who has already established their credit (and has a good credit score) because that person serves as a co-signer. The co-signer has to understand, and be willing to take on, the responsibility of the loan if you do not make payments or pay it in full. This is a great option for younger individuals trying to establish credit.
Be an authorized user on another individuals account
A family member or significant other may be willing to add you as an authorized user on his or her card. Doing so adds that card’s payment history to your credit files. But you don’t have to have the card in your possession or use it to get the benefits. Here are some things to look for in an account to be an authorized user:
- A primary user who has a long history of paying on time
- Primary user has a good credit score
- The account activity reports to the 3 credit bureaus
- Form an agreement for terms for if/how you will use the account
Buying a Home
Owning a home has many benefits. You have free reign to customize it, such as painting the walls, putting in a garden or replacing permanent fixtures. Everyone needs a place to live, so typically a home will go up in value each year. Depending on how long you stay in your home, you could receive a return on your investment. Purchasing a home also provides many tax benefits. Wondering if you would qualify to purchase a home? Click here for information on mortgages, mortgage rate quotes or to apply.
Student loans can be considered good debt because you are acquiring funds to attend school, earn a degree and get a higher paying job. There are a few things to keep in mind when getting student loans:
- Is your area of education in high demand?
- Will you be guaranteed employment when you graduate?
- Could you get paid a similar salary without going in to debt for education?
- Do you have enough income to pay the interest before it accrues?
If you are willing to do some research and have a solid plan for your education, a student loan would be “good debt.”
Bad debt is any situation where you are not growing your net worth or you are depleting your credit score. Any loan or credit card could turn in to bad debt if you are not following the terms of your agreements.
When considering taking on more debt, financial institutions will look at your Debt-to-Income Ratio. This means they will see how much income you have, how much debt you have, and see if adding more debt is feasible. For more information, you can read about Debt-to-Income Ratio in our blog Successful Budgeting.
Some examples of bad debt are:
High Interest Credit Cards
If your interest rate is above 15%, it could make it very hard to ever pay down your card because the interest accrues quickly and the minimum payment is often low. If you have a high interest credit card, it may be beneficial to talk to them about lowering your interest rate. Some credit card companies will reduce your interest rate based on longevity of your account, payment history or credit score. Ascent Credit Union offers a very low-rate credit card called the Go2. You could transfer your balance from the high interest card to this one and save money!
Quick or Payday Loans
A payday or quick loan is a loan that is meant to be short term to get you through until your next paycheck. These types of lenders typically charge very high interest rates. If you do not pay these loans back quickly, it can be very hard to get out of it. For these situations, we recommend talking with your credit union or borrowing from a family member.
We want you to make the best financial decisions for you and your family. Hopefully you are now more aware of the difference between “good debt” and “bad debt.” If you have any questions on types of loans, credit cards or mortgages, our staff is here to help. Give us a call or check out our website.