Living Frugal
What's the difference between good and bad debt?

You should understand the differences between good and bad debt to make smarter decisions about your money and begin to live frugal and become debt free.

As a general rule, most financial advisers will advise that a person have no more than 36 percent of their total gross income going toward debt payments. This does include your house, car, insurance, medical, credit card and student loan payments. This includes both good and bad debt.

If a debt increases the actual amount to be paid for a product but the product doesn't increase in value, it's a bad debt. If a debt is used intelligently to build wealth, it's a good debt.

Good and Bad Debt, the difference in a nutshell:

When you buy an item on a credit card or loan and the item immediately decreases in value, it's a bad debt.

When you borrow money to buy an item that will result in increased value, it's a good debt.

When you have a debt that is tax-deductible or that could produce more income in the long run, these are good debts if you pay them off as quickly as possible. The general rule here is to pay off the debt so it does generate income and you aren't putting the income toward the interest on the debt.

If you take out a credit card debt loan such as a home equity loan to pay off a high interest rate credit card, it is considered good debt providing you pay it off as quickly as possible.

Most times, buying a residence or refinancing to reduce high interest rates is good debt and is generating limited debt. The extra money can be used to buy investments that are guaranteed to meet expectations within a short period of time. (Do not take out a home equity loan to invest in the stock market. The market is volatile and does not justify a home equity loan).

In all cases, a credit card will generate bad debt if you do not pay the balance in full every month. It's called a bad debt expense and you get caught in a cycle. Unfortunately, once you are caught in the cycle of bad debt it takes a lot of effort to pay it off. Stopping the cycle is the first step in the process. Stop buying using a credit card and start living frugal to eliminate debt. You'll be glad you did in the long run. It'll be a great feeling when you're debt free and living frugal.

It's imperative you know the difference between good and bad debt so you can get started paying off those bad debts first.

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