Debt can be classified as good or bad. Good debt includes anything you need but can't afford to pay for up front without depleting cash reserves or liquidating all your investments. Bad debt includes debt you’ve taken on for things you don’t need and can’t afford. Assessing and organizing your debt can help you pay it down effectively. Here are some easy ways you can balance good and bad debt:
-
Reduce your variable spending and put the extra money toward your debt payments. Once you determine the maximum amount you can pay off each month, pay down the debt with the highest interest rate first—which usually is your credit card balance—while paying at least the minimum monthly amount due on all other revolving bills.
-
Good debt brings some form of long-term benefit to the consumer and can be thought of as something that appreciates over time. An example is your mortgage because it is a way to build equity and it is most likely your biggest asset. Each time you make a payment toward your mortgage, you increase the equity in your home while shrinking the amount of debt you’ve accumulated. Other types of good debt include student loans, business loans and home improvement loans.
-
Do not fear bad debt. Debt that is classified as bad debt, such as a car loan, is a necessity for most people. When you purchase a car, the vehicle depreciates considerably as soon as you drive it off the lot, but you’re still saddled with the principle of the loan plus any accrued interest. Therefore, it’s important to develop a plan to pay off those debts as soon as possible so you can have control over your bad debt.
-
Leverage your good debt. Good debt is synonymous with leveraged debt. This refers to the process of using debt in order to create multiple streams of income. Leverage is related to the amount of money you have invested as compared to the value of the investment.
-
Sometimes the decision to borrow doesn’t depend upon how much cash you have but on whether there are ways to make your money work harder for you. If interest rates are low, compare what you'll spend in interest on a loan versus what your money could earn if it were invested. If you think you can get a higher return from investing your money then borrowing a small amount at a low rate may make sense.
Knowing your debt obligations will help you balance your good and bad debt and ultimately help you lighten your debt load.
