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Debt. Not all debt is bad, but not all debt is good either. So, what's the difference between good and bad debt?
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Hey everyone, welcome back to the channel. Today I want to talk about something that confuses a lot of people. Debt. Not all debt is bad, but not all debt is good either. So, what's the difference between good and bad debt? Let's break it down. Hi, my name is Prince Chenou. I work at a big financial institution and I come on here just to make educational videos to help anybody who's out there willing to listen.
So, if that sounds like you, let's get into it. So, what is debt really? Debt is essentially money you borrow from a bank or a lender or credit card company with the promise to pay back with interest. The key is how you use that debt. That's what separates good and bad debt. You can have different types of debt like a car loan, a student loan, credit card debt, or business loan.
There all many forms of debt out there. And in this video, I want to talk about how to understand if a debt is good or bad. At the end of the day, it's not about how what kind of loan someone takes. It's more about why they need it and how they use it.
The purpose and the responsibility behind the loan matters more than the loan itself. When used wisely and for the right reasons, any loan has the potential to create a positive impact on someone's life. So, to start off, what is good debt? Good debt is money that you borrow to purchase something that has the potential to grow in value or to put money back into your pockets over time.
It's not just spending, it's strategic. Think of things like a student loan that can lead to a higher earning potential or a mortgage on a house that appreciates over time or a business loan that helps you generate income. In these cases, the debt serves as a purpose, a tool to help you build wealth.
That's why we call it good debt. It's not about avoiding all debt. It's about using it wisely. Now, in this case, let's look at a student loan. Taking out a student loan to earn a higher degree is often considered good debt, especially when it's tied to the goal of landing a higher paying job or advancing your career.
While it may take time to pay it off, and the investment in the education can lead to a greater earning potential, more job opportunities and long-term financial stability. Even if the return isn't immediately visible in your bank account, the knowledge and skills and the doors that it opens can incredibly be valuable. This could be seen as a smart use of debt because it's an investment in yourself and your future.
Another example is taking out a mortgage. The idea behind real estate being a good debt is the property often appreciates over time, meaning that you increase the value the the longer you hold on to it, especially if you make improvements or you build what's called sweat equity by putting in work for renovations.
At the same time, you're cons consistently paying down the mortgage and you're building ownership in the property, also known as as equity. Equity becomes very valuable asset. And when it's time to sell, you have a good chance you'll be able to walk away with a profit after paying off the remaining loan balance.
So, not only are you securing a place to live, but you're also growing your net worth within the process. So, for example, let me share with you my own experience with taking out a mortgage. Little over nine months ago, I bought a house. And yes, I had to take a substantial mortgage to make this happen.
But there was two things that I did that made me feel confident about this decision. First, right after purchasing the house, I immediately started making renovations to increase its value. I completely fixed the deck. I renovated the primary bathroom. And I've continuously made upgrades to add value over time. The goal is to somebody to either sell for a profit or to rent out down the line.
Second, I made sure that the mortgage payment fit comfortably within my budget. That was a non-negotiable for me. I didn't want to stretch myself too thin and wanted to make sure that this loan works for me and not against me. Now, finally, let's look at another example. Business loans. When used strategically, borrowing money to start or extend business can be a powerful way to generate significant income and fuel long-term growth.
Taking out a loan to invest in equipment, inventory, marketing, or a new hire can help your business reach new customers and increase revenue. If your business succeeds, the profits you earn can far outweigh the cost the loan turned out the initial debt in into a smart investment. Over time, this approach not only helps you build wealth but also creates an opportunity for future expansion and financial stability.
So in totality, it's about the use of the debt as the tool to create value rather than creating a financial strain. Good debt helps you to build assets that grow in value and generate income over time. It's an investment in your future rather than borrow money to cover short-term expenses or that or that won't contribute to your long-term financial health.
Now on the other hand, what's bad debt? Let's talk about it. This type of debt usually used to purchase things that lose value over time or generous or doesn't generate any income and often with high interest rates. In most cases, you're taking liabilities rather than building assets. Liability is something that takes money out of your pocket instead of putting money into it.
It's an obligation or expense that doesn't appreciate in value or generates income. Unlike assets, which helps you build wealth, liabilities typically reduce the net worth over time. So, let's look at an example. Credit card debt. Many people use credit card debt to fund everyday purchase spending like dining out, shopping sprees, or other non-essential purchases.
The problem is that these items typically lose their value quickly and don't provide any lasting benefits. Meanwhile, the interest rates on the credit cards are often very high. And if you don't pay them off the balance within the full month, the interest continues to acrue over time. This can lead to a growing debt load that's difficult to manage and can seriously harm your financial health.
Instead of helping you, credit cards can keep you trapped in a cycle of payments with little to show for it. Now, let's look at car loans for example. Many people see the car as an investment, but the reality is quite different. The moment you drive your new car off the lot, it loses a lot of value immediately, sometimes as much as 20% within the first year alone.
Unlike a true asset, a car generally doesn't appreciate or generate income. And when you finance a car with a loan, you essentially borrow money to pay for something that loses value over time. In some cases, taking out a car loan makes sense. But when it's used to buy a vehicle that's beyond your budget or is more than what you can reasonably afford, it can really set you back financially and create unnecessary stress.
Now, let's take a let's look at payday loans for instance. They're often pitched as a quick fix or an emergency cash solution, but they come with some of the highest interest rates you'll find anywhere. Payday loans usually have very short repayment periods and often just a few weeks which makes the total cost much higher than the amount you originally borrowed.
Many people find themselves rolling over these loans multiple times paying fees and interest that add up fast. Because payday loans don't h help you build any assets or increase your income. They're considered one of the worst types of debt. They're expensive, shortterm, and can quickly drain your finances, making it difficult to break free from the cycle of borrowing.
Overall, bad use of debt doesn't take your money. It takes your momentum. It slowly drains your income through high interest payments, adds to your liabilities, and make it harder and harder to build real wealth. Instead of moving forward, it keeps you trapped in a cycle of paying off something that isn't adding any long-term value to your life.
The true danger of bad debt is that it looks small at first, but it costs you big over time. Now, let's talk about some important questions you can ask yourself what whenever you're considering taking on debt. First, think about whether this debt is actually help you grow financially in the future. Would it increase your value over time or would it generate some type of income down the road?
If the answer is no, that's a potential warning sign. Next, consider the interest rate. Is it reasonable and manageable? Or is it so high that you can barely breathe and you're worried about quickly spiring out of control? High interest rate can turn even the smallest loan into a big financial burden. Another key question is whether you can comfortably afford monthly payments without stretching your budget too thin.
If the payments force you to cut back on essentials and push you into more debt, it's probably not a smart move. Finally, ask yourself, would this loan actually put me ahead financially, or would it hold me back? Would it help me build wealth and improve my situation, or would it keep me stuck in a cycle of paying off debt?
These questions can help you make smart decisions and avoid bad debt traps. Like I said earlier, it's not about the type of debt that you have. It's about the purpose behind it and how reasonable you are or responsible you are using it. Whether it's to student loan or mortgage or even a car loan, what truly matters whether it is helping you move forward financially.
We use it intentionally and discipline. Any loan has the potential to possibly shape your future.
This video is for general educational purposes only and is not personalized investment, tax, or legal advice. Every situation is different. Talk with a qualified professional about your circumstances before acting. PLC Wealth Partners is a registered investment adviser. See our disclosures.
