The Difference Between Good Debt and Toxic Debt

The Difference Between Good Debt and Toxic Debt

Is there any such thing as good debt?

We’re all nervous when we have it, and we’re in good company: the total U.S. consumer debt is at $14.9 trillion. That includes mortgages, auto loans, credit cards and student loans.‍

Student loan debt is especially prevalent, with students holding a projected $1.5 trillion in federal student loan debt.‍

So should we cut up our credit cards and avoid debt like it’s the plague?

Not so fast.

All forms of debt are certainly not created equal, and an important step in becoming financially literate is better understanding the differences between good debt and toxic debt. Understanding this distinction is an important part of building the right kind of credit and setting yourself up in a strong position to build wealth and financial independence.

What is Toxic Debt?

It’s important that we define what exactly we mean by debt in order to de-stigmatize the debt crisis in America. 

Yes, about 1/3 of Americans struggle with debt. 

But there are varying levels; above all, it’s critical to avoid toxic debt.

Some examples:

• Credit card debt; It’s estimated that about 10% of 18-29 year olds are at least 90 days overdue on their credit card bills. Clearing this debt away is almost always the goal they should focus on taking care of first, even before paying off student loans or saving for retirement.
• Needless consumption; Credit card debt is often invariably fueled by the act of consumption and purchasing assets that are only depreciating in value. Think of spending tens of thousands of dollars you don’t have on a flashy car to impress your Instagram followers – a purchase that is only dropping in value the moment you drive it off the lot..

Countless Americans destroy their long-term prospects for creating wealth by borrowing money from tomorrow to meet today’s wants. 

Unfortunately, an entire industry has emerged of predatory loans with eye-popping interest rates and details buried in lengthy contracts – all designed to confuse and take advantage of consumers.

What is Good Debt?

Good debt, however, holds the potential to increase your net worth and wealth over time. You can, in fact, borrow money that will help you to enhance your quality of life.

Some examples:

• Student loans; BUT – and it’s a big BUT – if it comes with a logical plan for paying them back. Graduate programs, in particular, have come under recent scrutiny over whether the expected salaries justify the rising costs of tuition. Whether or not education should primarily be focused on vocational training is a broad discussion, but the fact remains: don’t take out a school loan if it won’t likely lead to a logical ROI.
• A mortgage; home ownership isn’t for everyone, but it remains the wealth building vehicle of choice for most.
• Reasonable credit card spending; one of the best ways to build your credit history – and qualify for favorable mortgage loans – is to consistently demonstrate your ability to pay off your monthly credit card. If you are disciplined, using your credit card to buy your groceries will earn you a higher credit history (and earn you credit card rewards in the process).

The next time you whip out your credit card, ask yourself – is this purchase an example of good debt? Or toxic?