Is there a good type of debt? What most people think when they see any type of debt is a big, red X. They think that all debt is bad. In a way, they are right. Having debt means you are paying someone else interest until you can make payment on what you owe. However, there are good types of debts. In fact, you’ll want to invest in these types of debts for the sole reason of establishing your credit history and achieving your financial goals.
Why Some Debt is Good for You
Some types of low-interest debt are good for your credit history. Let’s say, for example, that you want to obtain a higher credit limit credit card. When you apply for that loan, the lender takes a look at your credit history (not just your credit score) to determine if you are a good risk or not. In doing so, the lender wants to see if you have some history of making payments on time.
- A person who has not had any credit history and has no debt cannot prove that he or she is a good risk to this new lender. In other words, the lender doesn’t know if lending to you is a good thing.
- A person who has some debt, such as secured loans on cars or homes, and makes payments on time, has a credit history. The lender can tell if this person is a good credit risk or not because there is a history.
Keeping this in mind, you are likely wondering what types of debt are right for you.
What Debt is the Worst of it?
Some types of debts are better than others are. Consider the following types of debt and their affect on your credit score.
Good Debt: Mortgage Loans
This is a good type of debt. When you are buying a home and making payments on a mortgage, you are establishing a solid credit history. Plus, the interest rates on mortgages are very low. Add to this the fact that you are building equity, which you can tap into at a later time if you need to, and you have a very good debt option. In addition to this, the interest is often a tax deduction. Car loans and personal loans, although not as beneficial, are in the same boat as mortgage loans when it comes to good debt to carry.
OK Debt: Credit Cards
Credit cards are a toss up because they can be very beneficial to your credit score, but they also can make it easy to take on a lot of debt. Plus, credit cards have high interest rates and are rather easy to get. Even worse are credit cards with low credit limits, since they do not prove your ability to manage a large amount of debt. Be careful when choosing a credit card. Make sure you can pay off the balance each month, and get a card that has excellent rewards so they can help you maintain a healthy credit profile. Here is a good list of great credit cards for 2014.
Bad Debt: Student Loan Debt
With very high balances, student loan debt is a bad debt. Some experts say student loan debt is the worst type of debt to get into, too. It is given to students who are young and without credit history, so there are very few qualifications supporting it. It also takes a long time to repay. And, in the worst case scenario, this type of debt is often unable to be discharged during bankruptcy – that’s a stark difference from nearly any other type of debt you may have.
Bad Debt: Loans of Last Resort
These types of loans are the absolute worst for your credit score. They basically say that you cannot manage to get a standard loan, so you are resorting to these less-than-optimal loans. These include payday loans and store financing in some cases. Avoid these loans at all costs.
As a direct result, consumers who want to take on debt to build credit should invest in a mortgage loan or even a low-interest rate credit card. Auto loans can be a good option if they are affordable. Ultimately, avoiding student loans as much as possible is necessary. And, working to keep debt down is always a good thing.