Some personal finance oxymorons seem to make no sense whatsoever, such as “bankrupt millionaire” or “negative income.” Yet none of them sound as baffling as one of the most contradictory paradoxes of all: “Good debt.”
Is a college education and student loan debt a good thing? Or does it all add up to one big, bad investment? Knowing the difference can prepare you for the financial impact that debt brings.
Good debt vs bad debt
What makes bad debt so bad? In a nutshell, bad debt is borrowing money to pay for something that diminishes or drops in value over time.
An auto loan is a perfect example of bad debt. Not only does potentially high interest add to the total amount of principal borrowed, but the car you bought is a depreciating asset. That’s not including the maintenance, insurance, and gas costs that can add to the total cost of the car.
Credit cards can be a good form of revolving debt, but can become one very bad type of debt if you let your balance build up, since penalty interest can become unmanageable.
If you’re paying off another form of long-term debt, a credit card may only add to the problem. Yours may earn rewards — a nice perk — but they may not be worth the risk of a large balance.
Other forms of debt, like payday and cash advance loans, come with insanely high interest rates that can eat your budget up alive. Big-ticket purchases that need to be financed, like luxury items you don’t need, can be considered bad debt since they don’t appreciate in value.
What is good debt, exactly? It’s about borrowing money for something that will appreciate or increase in value and make your loan worth the investment, time, and money.
Mortgage loans are usually considered a good type of debt. Unlike a car, a house is hoped to increase in market value over time. If you sell it years down the line, you’ll ideally net enough of a profit to offset some of the principal and interest you’ve paid on the loan.
Home loans also tend to carry lower interest rates and the interest you pay is tax deductible, adding to your overall savings. Investing in a rental property is another way to offset a mortgage or real estate loan.
Entrepreneurs who take out a small business loan may also be staying on the good side of debt, since the money they put into paying for overhead, office space, equipment, employee training, and salaries should pay off over time if their venture is a success.
Are student loans good or bad?
In the good debt vs bad debt debate, student loans fall into a gray area. Student loans can be considered good debt because the money you’re borrowing to attend school is your ticket to earning a degree and getting hired at a well-paying job. That debt should pay itself off over time with a lucrative career in place.
On the other hand, that degree does not guarantee employment. Student loan debt currently exceeds the $1.2 trillion mark, with more than 43 million borrowers struggling to pay off their loans.
As of last month, 8.1 percent of Americans aged 20 to 24 years old remain unemployed — a bad sign for undergraduate and graduate degree holders unable to find work and pay down their debt.
Student loans may be the hardest type of debt to narrow down to simply “good” or “bad,” since everyone’s financial and lending needs may differ. Examining some of the basic pros and cons can help you decide if it’s the type of debt for you.
Student loan pros
- Student loans allow you to pursue a college education without having to pay for your entire tuition in full. With a college degree, you improve your chances of finding well-paying, stable employment.
- Some federal loans are subsidized. If you qualify, you’ll have your interest paid off during select periods of time.
- Interest rates on federal loans are lower than most other lending products; fixed, regardless of your credit standing; and tax deductible.
- Student loans come with a variety of repayment plans (standard, graduated, extended, income-based, etc.) that can make your loan payments easier to align with your budget.
- You have opportunities to refinance, consolidate, defer, or forbear your student loans if you’re struggling with debt.
- With timely, disciplined payments, student loans can add positively to your credit history and score.
Student loan cons
- Even though a college education can improve your chances at gainful employment, there are no guarantees.
- Entry-level workers fresh out of college also may not earn enough to comfortably afford their loan repayments. The high amount of debt compared to a lower salary can produce a skewed debt-to-income ratio, which can hurt your credit.
- Student loan debt can lead to delinquency and default, each of which can ruin your credit score and inhibit your chances at being approved for other types of credit.
- Student loans can’t be discharged in bankruptcy.
- Consolidating federal loans means relinquishing some built-in privileges.
There’s no such thing as good debt
When you weigh the pros and cons, there’s really no such thing as good debt.
That is, unless you’ve got enough money on hand to pay down the majority of your interest before it accrues — but if that was the case, there wouldn’t be much of a reason to take out a loan in the first place.
You might perceive student loans as a type of “better” debt than most, since the value of a college education is like an appreciating asset unto itself. The higher your degree, the more attractive you likely become to future employers.
From a financial standpoint, it’s often a necessary evil for students who don’t have the luxury of grants, scholarships, or other aid to cover the bulk of their tuition costs.
Borrowing money for student loans may be unavoidable, but by managing your debt carefully, you can shift it from bad to good.
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