Paying down your debt or eliminating your debts can be one of the best financial goals you can set for yourself. There are a lot of decisions you'll need to make in order to create an effective plan to accomplish your goal, but a solid understanding of the differences between good debts and bad debts can help you make the best choices along the way. In this lesson, you'll learn about the characteristics of both good debts and bad debts. You'll be able to categorize all debts as either good debt or bad debt, and you can use this information to determine your own financial priorities, maximizing every dollar you earn. One of the simplest ways to separate good debt from bad debt is to look at the interest rate. Good debts have low-interest rates and by low, think about anything that's less than 7 percent. Bad debts have high interest rates, generally, anything 7 percent or higher, higher interest rate debt is bad because it's expensive. The interest can accumulate and in many cases compound quickly. Another way to differentiate good debt from bad debt is to consider whether the debt is secured or unsecured. Secured debts or debt for which you have pledged collateral, such as a car or a home tend to be good debts. By being secured, a lender can typically offer a lower interest rate. Unsecured debts like personal loans or credit cards, often come with much higher interest rates, and having numerous unsecured debts can be considered risky by lenders. Now, that you know some of the characteristics you can use to classify debts, let's talk about some of the most common types you can expect to have. As a reminder, good debts are generally low-interest-rate, secured, installments, and healthy for your credit. Common examples of good debt include mortgages, car loans, student loans, and asset-backed lines of credit. Mortgages and student loans even have the added benefit of coming with potential tax deductions. All of these good debts are debt that you use as a tool, and for all of the reasons you would classify these as good debts would also be reasons to make paying them off quickly a low priority. If you are in the position where you only have good debt, you can feel very comfortable choosing to save and invest for other goals first, before aggressively paying down these types of debts. A strategic approach to building wealth would be to pay only the minimum on your good debts each month and put any excess money you have available into investments instead of making an extra payment on the debt. If you have bad debt, paying it off is a high priority. As a reminder, bad debts are typically high-interest rate, about 7 percent or higher, unsecured, and revolving. Common examples of bad debt include credit cards, personal loans, and unsecured lines of credit. It's important to appreciate that credit cards themselves are not bad, but rather carrying balances on credit cards would be considered bad debt. This is true even if you have a credit card balance on a zero percent interest rate. Bad debts are more expensive, have a propensity to grow over time, making it very challenging to get out of debt, and carrying these balances can often damage your credit score, meaning that future debts you obtain may be at higher interest rates, costing you more money over your lifetime. If you currently have a bad debt, you should feel confident in the decision to focus on paying your debt down as quickly as possible. By allocating more money and effort towards paying down your high-interest debt, you will save money and become debt-free sooner. A common concern I hear from members who are paying on high-interest debt is that they feel like they're missing out on investing. But if we look objectively at the realistic potential return on an investment portfolio against the cost of high-interest debt, your money will go further paying down the debt. As you move forward with your debt pay-down efforts, it will be important to prioritize your debts accordingly. Have both good debt and bad debt, focus on eliminating your bad debt first, then focus your energy on investing and saving for the future, all while making the minimum payments on your good debt.
