Debt: Is it a Necessary Evil? | Tips to Navigate Debt and Turn Bad Debt to Good

When you are building wealth, it is important to understand that not all debt is bad. In fact, to build your credit score, you have to incur some debt to establish a positive credit history, which will help you access more good debt to use toward wealth-building assets. So, debt may be considered a necessary evil by some, but it is one you can navigate well, if you have the right tips and you understand how to turn bad debt into good debt and use it to your advantage in building wealth.  

What is Good vs. Bad Debt?

It’s important to remember that not all debt is bad. Debts with low interest rates are the best ones to keep. When your investments are earning a higher rate that your debt, your money has positive momentum. With the low rates, you can make minimum payments and leverage your extra money in a better way than focusing on paying off that low-cost debt. 

Bad debt is debt with high interest rates or debt incurred to buy personal items that do not generate income (non assets). Those are the ones you should avoid, or if you already have bad debt, you should focus on paying that debt down first. 

 

What Are Examples of Good Debt?

Good debt is debt that has a low interest rate, it can be paid back responsibly, and preferably, the purchase you are making with the loan is an asset or investment that will increase in value and give you an extra stream of income. Small business loans or a low interest line of credit are good examples because you can use the money from both to build an asset that pays you. 

Real estate purchases are also a good debt, especially if you can use them to create rental income that will pay you on a monthly basis. The goal is to have positive income after you pay the debt and other related expenses.

While a mortgage on your personal home is often considered good debt because it has a low interest rate and it is a purchase of an asset, it is important to consider that a mortgage doesn’t pay you each month. The house may increase in value over time, but it is not a guarantee. 

The decision to purchase a home, or invest in real estate as a stream of income, is one each person needs to make for themselves, based on their bigger vision and the lifestyle they want to live.

 

What are Examples of Bad Debt? 

Bad debts are ones that have a high interest rate attached to them and relate to personal items or luxuries. A high interest rate drives up the minimum payment required each month, which directly affects the amount of money available at the end of the month to pay down your debt or build wealth. 

Examples of bad debt are:

• Credit cards
• Payday loans
• Auto loans (most cars are depreciating assets)

How Do You Turn Bad Debt into Good Debt?

Your first step must be to understand where your money goes. 

That bigger financial picture will help you create a financial plan that works for you and where you are right now in your life. 

How to Focus on Your Finances – Wealthy Insights to Get Ahead and Stay There! will give you the steps to start building a financial plan. 

Next, look at all your sources of debt. 

Write down their interest rates, the amount of debt owed on each, and the minimum payments that are required. Some people like to focus on the source of debt that has the least amount owed, to clear it off quickly and gain a win. Others like to pay off the debt with the highest interest rate first or the one with the largest amount owed. No matter which you choose to do, make the commitment to put any excess money at the end of each month toward clearing your bad debt.

Finally, stick to your plan. 

No matter where you are right now with your finances, you can create a financial plan that works for you. Even paying a few extra dollars each month to bring down your bad debt matters, and each payment is a financial win for you!

The steps for navigating bad debt are simple, it’s each person’s commitment to stick to the plan that matters most. Your fortitude will help you take the necessary evil of debt, turn bad debt to good, and then use it to acquire the assets to create true financial freedom. 

Remember that bad debt creates negative momentum with your wealth, while good debt used to buy, create or build income-producing assets creates positive momentum for your wealth.

You are financially free with the income from your assets exceed your monthly expenses.