Debt isn't always bad, especially when it boosts your personal wealth in the long run.
Paul Kuzmickas, who has helped many clients file for bankruptcy protection, said it's not unusual for many of these clients to believe that all debt is "bad debt" because of their unfortunate financial experiences.
But Kuzmickas, a bankruptcy attorney based in Cleveland, says that this isn't true. There are bad forms of debt, of course. But there is also good debt that can help you build your credit score as you pay if off.
Consumers--especially younger ones--often have to steadily build their credit scores by accumulating debt and then paying it off. Until they do this, these consumers might have a low credit score or no credit score.
"Most people need to borrow money to buy life's 'big-ticket' items," Kuzmickas says. "While some might consider all debt as bad debt, that is not always the case. There are several forms of debt that can be viewed as good or smart debt."
5 types of good debt
As you look to build your credit score, it's better to incur certain types of debt than others. For example, mortgages, student loans and low interest unsecured personal loans are often considered good debt, while credit cards, title loans and payday loans can be examples of bad debt. Here are five signs that the debt you are taking on is smart debt:
1. Good debt boosts credit score: personal loans
Your credit standing is crucial because lenders rely on your three-digit credit score to determine if you qualify for loans and what interest rate you'll pay on the money you borrow. Employers may use credit scores when deciding which employees to hire. It can also affect your annual expenses as your insurance company might look at your score when determining how much to charge you for auto insurance.
Ideally you want your on-time payments to be reported to the three national credit bureaus: TransUnion, Equifax and Experian. When these on-time payments show up on your credit report, your three-digit credit score should improve. According to credit score provider FICO, your payment history accounts for 35 percent of your credit score.
Look into debt payments that boost your credit score, which include mortgages, personal loans, student loans and credit card purchases. Why is a mortgage considered good debt? Mortgage loans typically have low interest rates and certain mortgage interest expenses are often tax deductible.
2. Good debt has a low interest rate: mortgage
The best type of debt is debt that comes with low interest rates. Today, that includes both mortgage loan and some student debt. The low interest rates mean that this debt grows more slowly than does high interest rate debt, like the debt you accumulate from making purchases with your credit card.
If possible, make sure that the majority of your debt comes with a low interest rate.
3. Good debt helps you accomplish a goal: student loans
Know how to use good debt to get ahead in life. Again, student and mortgage loan debt top this list. Mortgage debt allows you to buy a home that you can build equity in. Many homeowners have the goal to sell this residence one day for a profit. Student loan debt helps you gain a college degree, one of the best ways to ensure that you'll earn more money throughout your adult life.
"While the media are very concerned -- rightfully -- about the amounts of debt students are graduating with, student debt can be very beneficial," says Eric Meermann, portfolio manager with Palisades Hudson Financial Group's Scarsdale, New York, office. "Taking on this debt allows you to improve your skills, gain an education and a degree and hopefully make yourself more marketable to future employers."
4. Good debt is not oppressive: home equity loan
Which is an example of bad debt? Debt that weighs more heavily on you than others. High interest credit card debt is usually attributed to consumers' money woes. Yes, charging items on your credit card and paying them back in full every month can help you build your credit score. But carrying a balance on your credit card from month to month can put you in a financial hole.
This is why Tom Anderson, a Chicago-based private wealth manager and author of the book "The Value of Debt in Retirement," recommends that you speedily eliminate any debt that comes with an interest rate of 10 percent or higher.
A home equity loan or home equity line of credit can be useful to accomplish a home improvement that adds to your home's resale value. If you borrow only as much as you need and can comfortably repay, you might not feel the debt is a burden.
5. Good debt can help you earn money: investing
Kuzmickas says that it's smart to take on debt for something that may eventually help you generate income. He points to student loans as a big example, but borrowing for another wise investment can also make sense.
"You're investing in your future," he says. "An education will help you generate an income post-graduation."
Tell us: Do you feel the debt you have now is good for your finances or is it stopping you from achieving what you want?
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