28 Feb Good debt or bad debt? Do you know which is which?

Most of us hate the idea of “debt”.  It represents something that is owed: an obligation we’d rather not have.  And we always have the niggling feeling that the lender is benefitting much more than the borrower in the transaction.  But not all debt is actually “bad”.  Good debt can give you leverage to more quickly achieve your financial goals. The trick is to have more good debt than bad debt.  Bad debt makes it much harder for you to achieve personal wealth.

Can you tell good debt from bad?  Try your hand at answering the five questions on this quick quiz.

1.  CREDIT CARDS: Good debt or bad debt?
Aha!  Okay, this is a bit of a trick question.  Those of you who read my post on credit know that credit cards can be extremely helpful as a way to generate credit history.  A great way to establish credit or repair bruised credit is to activate and use a low-interest credit card. Pay the balance each month, and keep your oldest credit cards for as long as you can – because it gives you a good long credit history. However, keeping any balance on your credit cards (especially if it’s above 30% of the limit), and making only minimum payments, is a recipe for financial problems. You’ll pay large sums of interest, and might find yourself in a battle with unmanageable debt.

2.  MORTGAGE: Good debt or bad debt?
This one is easier. Mortgages are almost always good debt. In Canada we are currently benefiting from historically low mortgage rates, and real estate is still considered by many to be an excellent long-term investment in most areas of Canada. A mortgage lets you build wealth in your home by using low-interest debt. Be sure to talk to a reputable mortgage professional if you’re in the process of obtaining a mortgage.  They will help you shop the broadest range of rates and options for a mortgage that’s specific to your unique situation and to help you achieve yoru financial goals as fast as possible.

3.  INVESTMENTS: Good debt or bad debt?
Borrowing to invest can be good debt if the investments help improve your overall financial position. In some cases, the interest expense on money borrowed for non-registered investments is tax-deductible. Many Canadians will also borrow money to maximize their RRSP contributions. That’s also often good debt, since you’re investing in your future, and benefiting from tax-sheltered investment growth.  One caveat however – always be sure to get professional investment advice.  And remember, if an investment sounds a bit too good to be true, chances are, it is. If anything about the scenario doesn’t make sense to you, trust your instincts and stay away.

4.  CAR LOAN: Good debt or bad debt?
A vehicle begins depreciating the moment you drive it off the lot, so it’s a purchase that will decline in value.  Because of this, car loan debt does not contribute to your long-term wealth.  That said, for many of us, a car is a necessity.  But you’ll want to be very careful with car loan debt – don’t buy more vehicle than you need, do the legwork to make sure you have found the best possible loan rate and terms, and pay the loan off as quickly as possible.

5.  BUY NOW PAY LATER: Good debt or bad debt?
Nine times out of ten, you’re better off to avoid these “deals”. This purchasing trap has been a slippery slope for many Canadians in debt. It usually involves an item (furniture, electronics) which will begin to lose value immediately.  Lenders often add financing charges to the cost of the item, and often the interest rates – when they kick in – are shockingly high.  Make sure you read through the fine print!  What’s more, if you do enter into a buy now pay later arrangement, and you’re in the middle of getting mortgage financing, the eventual monthly payment will need to be counted as a debt when you are getting qualified.  I’ve seen this cause major problems.

So, how did you score?

Do you have a good handle on your debt, or still a ways to go before you’re happy with your financial know-how?   Let me know what you think!

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