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Good Debt Vs. Bad Debt: Know the distinction

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Good Debt vs. Bad Debt: Know the difference

Good debt can help you achieve goals, while bad debt can be costly and could cause them to fall off.

Written by Sean Pyles Senior Writer | Personal finance and debt Sean Pyles leads podcasting at NerdWallet as the producer and host of NerdWallet’s «Smart Money» podcast. The show «Smart Money» Sean talks with Nerds from NerdWallet’s NerdWallet Content team to answer listeners’ personal finance questions. With a particular focus on sensible and practical advice on money, Sean provides real-world guidance that can help consumers better in their finances. Beyond answering listeners’ money questions on «Smart Money» Sean also interviews guests outside of NerdWallet and also creates special segments that explore subjects such as the racial gap in wealth, how to start investing and the history of student loans.

Before Sean was the host of podcasts at NerdWallet the company, he also wrote about topics related to consumer debt. His work has appeared throughout the media including USA Today, The New York Times as well as other publications. When he’s not writing about personal finance, Sean can be found playing in his garden, going for runs and taking his dog on long walks. Sean is located in Ocean Shores, Washington.

Aug 5, 2021

Edited by Kathy Hinson Lead Assigning Editor Personal finances, credit scoring financial management and debt Kathy Hinson leads the core personal finance team at NerdWallet. In the past, she worked for 18 years working at The Oregonian in Portland in capacities such as chief of the copy desk and team editor and designer. Previous experience included the editing of copy and news at various Southern California newspapers, including the Los Angeles Times. She graduated with a bachelor’s in mass communication and journalism in The University of Iowa.

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Before you commit to any type of debt, you should consider whether you think a car loan or new credit card can assist in meeting your financial goals — or hinder them to accomplish. The amount you pay and the amount and cost, could make the distinction between good debt and bad debt.

A credit card, for instance, could be a means to financing big expenses while earning reward points. But if not managed carefully the credit card debt that comes with high interest could spiral out of control.

Here are general guidelines on good debt and bad debt and the best way to handle it in the event of having excessive debt.

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What is good credit?

Low-interest debt that helps you to increase your earnings as well as net worth, are an example that are good credit. But too much of any kind of debt — no matter the opportunity it may create can result in bad debt.

Medical debt, for instance isn’t a neatly categorized in»the «good» or «bad» debt categories. It’s a cost that is largely not controllable and doesn’t usually have an interest rate. It’s an expense that’s uncontrollable .

Student loans

Typically regarded as an investment in the future as a way to invest in your future, student loans typically have lower interest rates, particularly when they’re Federal student loans.

Guidelines: In general, try to make your student loan amount to be equal to your anticipated after-tax monthly earnings a year after graduating. If you expect to earn $50,000 per year, the maximum amount of borrowing is $29,000.

Take action: To handle overburdened student loans, look into such as refinancing and installment plans that are based on income.

Mortgages

Perhaps the biggest financial choice you’ll make, a mortgage can be the first step towards homeownership.

Guidelines: Be aware prior to shopping and limit your mortgage to 36% of your earnings.

Do something about it: downsizing your home, and/or moving into a lower-cost area could make housing costs more manageable.

Car loans

For many, a car is indispensable for daily living.

Guideline: Keep total auto costs, including your car loan payment, . Loan terms should be for four years or less, but typically with a 20% down payment.

Take action: or trading in a car that isn’t affordable can help you reduce car expenses.

What is a bad credit?

Inexpensive debts that affect your financial situation are considered bad debt. Examples are debts that have significant or variable interest rates particularly when they are used for expenditures that are discretionary or have value loss.

Sometimes bad debts can be good debts gone awry. For instance, credit card debt can be an illustration of this: If you have an interest-rate credit card that is high and you pay off your balance each month, it’s fine. However, if credit card debt builds up and you are unable to pay it off, you could get into trouble.

Credit cards with high interest

The high interest rates like those that are higher than 20% can increase the cost of debt.

Guideline: If you’re not making progress with paying off your debts with credit cards even though you’re paying everything you can each month, it could be a sign that you’re experiencing issues .

Take action: If you can keep your spending under control Try the strategy where you pay off your small debts first. It can make credit card debt less costly, though you’ll need good credit to be eligible for. If not, a credit counseling service from a credit counseling agency that is not for profit could be a viable option.

Personal loans for purchases that aren’t a necessity

Involving in debt to pay for expenses like a vacation or new clothes can be a costly habit.

The guideline is that personal loans can be a viable option when you have a particular goal in mind, like .

Make a move If you’re faced with the cost of a large personal loan and you’re not sure if you’re eligible to .

Payday loans

are considered a bad loan which can become toxic. They often come with rates of interest as high as 300% that can make them immediately unaffordable. These are short-term, small-amount loans meant to be repaid by the next pay period.

Guideline: Financial experts caution against payday loans because borrowers can easily be entangled in a debt cycle.

Explore options such as taking out a loan from the credit union or asking your family members for help.

The author’s bio: Sean Pyles is the executive producer and host of NerdWallet’s Smart Money podcast. His work has been published in The New York Times, USA Today and elsewhere.

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