Debt is one of the reasons the U.S. economy is currently in a downturn (and possibly headed towards a recession), but debt is also a major reason why there are more millionaires and billionaires today than ever before.

Debt can help someone’s finances spiral out of control, but it can also help someone build an impressive amount of wealth.

But how can that be?

Good Debt vs. Bad Debt

There is good debt, and then there is bad debt.  People who find themselves in financial trouble can blame “bad debt.”  Entrepreneurs who become millionaires can attribute their success to “good debt.” 

Debt usually carries a negative connotation, but not all debt is bad.  If used correctly, debt can help you build wealth and put you on the path towards financial freedom.

Examples of Bad Debt

Debt in any form gives you purchasing power.  You incur debt in order to buy something, whether it’s a widescreen TV, an education, a car, or a house.

The best way to determine if the debt you incur is bad debt is to ask the following question: “Is this debt helping me buy something that loses value?”  If the answer to this question is “yes,” you’re in the world of bad debt. 

Good Debt vs. Bad Debt graphic 2Here are two common examples of bad debt:

1) Credit Cards.  High consumer debt on credit cards is probably the # 1 reason why our economy isn’t doing so well.  In the past few years, people have placed boatloads of purchases on credit cards, not stopping to think when or how they would pay off their ever-increasing balances.  Moreover, these purchases usually involve assets that lose value (e.g., televisions, electronics, expensive gadgets, etc.).  If you’re placing numerous purchases on a credit card and not paying your balance off in full at the end of the month, you’re incurring bad debt.

2) Auto Loans.  Getting a loan to buy a car is one of the best ways to get yourself into bad debt.  A car loses over 50 % of its value in the first 2 to 3 years.  Thus, by year 2, the balance you own on the loan is likely more than the car is worth.       

Examples of Good Debt

Whereas bad debt helps you buy an asset that loses value, good debt helps you buy an asset that increases in value.  People like Robert Kiyosaki and Donald Trump are in debt millions and millions of dollars.  But it’s good debt, not bad debt, that they have and that helps them continue to build their wealth.  Here are two examples of good debt:Good Debt vs. Bad Debt graphic 2

1) Real Estate Loan.  A loan that helps you buy a piece of property is good debt because it helps you acquire an asset that increases in value at an average of 6 % per year.  Moreover, if you decide to rent out that property, you can generate positive monthly cash flow (i.e., passive income) that puts money in your pocket.  Thus, you get an asset that gains value over time and that puts short-term money in your pocket.

2) Business Loan.  A loan to help you start or grow a business is good debt because, like real estate, a business is an asset that gains value over time (provided it has valuable products and services and is property managed).  An SBA loan or a loan from a stranger like an angel investor gives you the funds necessary to invest in the business.  This investment, in turn, helps you get it off the ground or improve it over time.   

If you like this post, please consider subscribing to my full RSS feed.  You can also subscribe by e-mail and have a copy of each new post automatically delivered to your inbox.

If you like this post, please bookmark it: These icons link to social bookmarking sites where readers can share and discover new web pages.
  • del.icio.us
  • StumbleUpon
  • Propeller
  • Digg
  • Technorati
  • Reddit