When it comes to taking on debt it can be hard to decide whether the commitment is worthwhile or not. With varying interest rates and terms like ‘good debt’ and ‘bad debt’ floating around, debt can be an intimidating thing to take on. Debt itself can be an intimidating commitment, but with a bit of knowledge and understanding you can decide whether the debt you are thinking about taking on will be a good investment or a bad one.
What is bad debt?
Any investment that depreciates in value after you buy it is considered bad debt. If something you buy can’t be resold for a higher rate than you paid for it, you might end up sitting with bad debt in your portfolio. Some examples of bad debt include:
Most things you put on your credit card
Everyday expenses like clothing, dining out and entertainment activities that you can’t pay off immediately won’t increase in value once they’ve been purchased so would fall into the bad debt category. Anything that depreciates, generally, is not considered good debt.
A car, motorhome or RV
When buying a vehicle, you want to do everything you can to only spend as much money as you have to. You’ve likely heard the adage that vehicles depreciate in value the minute you drive them off the lot, and that’s very accurate. You’ll likely never be able to sell your vehicle for more than you’ve paid for it, especially when you take interest rates and dealer fees into account.
A cruise or vacation you can’t afford
If you need to put your vacation on a credit card and can’t pay for it outright, you are most likely taking on bad debt. No vacation can be resold for more than you’ve paid for it (if at all) and stretching out the payments over a number of months will have you paying a high rate of interest on the balance of the vacation.
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What is good debt?
Good debt is considered to be anything that appreciates in value from the time that you purchase it so that it ends up being worth more than the cost of your investment. Good debt can actually be beneficial to you because it can help you build up your credit and your overall borrowing power, which can then improve your ability to take on more good debt.
Borrowing to buy one or more investment properties or your own residence is almost always good debt, as long as you can afford the payments. Real estate typically has an ebb and flow, often on an overall upward swing, especially in the Toronto area. Any real estate that you buy whether as a flip, to rent out to tenants or to live in yourself is most likely going to increase in value over time. If you are able to time the market before flipping and reselling you have even more power in ensuring your debt is good debt. With interest rates holding steady, incurring debt for real estate is one of the cheapest ways to borrow money.
Though education may not present a tangible return immediately, an investment in education is a good one. Regardless of what kind of education you invest in, your returns are likely to increase when you put that education into practice. So just because you don’t get a tangible, immediate result for your investment doesn’t mean you won’t in the future. Like real estate, education can be a great long-term investment strategy.
Stock market investments
Making informed investments in the stock market can be considered good debt. To succeed in the stock market, you’ll need to invest time into learning the ropes so you don’t make bad or hasty decisions that could result in bed debt. A good stock portfolio or RRSP can become an asset that will overall improve your net worth.
Real Estate is a Safe Way to Start
The real estate market is one of the best ways to get started with investing and leveraging your assets. This investment strategy is one of the more stable options you can choose when looking to build your portfolio and increase your good debt in order to secure better lending rates and higher overall loans. With low interest rates, this debt is going to be one of the cheapest ways to borrow money and in turn, improve your credit and borrowing ability.
Borrowing to grow your wealth is a great strategy
As you can see, not all debt that you might take on is considered bad debt. It’s natural to have to take on some bad debt in your life, but if you can focus on taking on more good debt than bad and getting your bad debt paid off quickly, you can build a strong investment portfolio. A great portfolio can help you secure more good debt over time.