Good versus bad – the different types of debt

We’ve been taught to believe debt is bad. However, that’s not always the case. Good debt will often increase your future net worth, while bad debt will do the opposite.

Here’s a quick overview of what kind of debt is good or bad:

Student loans

A student loan is a good debt because an investment in higher education usually leads to greater earning potential and the ability to find a good-paying job. That additional income will add up over your lifetime. And if you get a federal or provincial loan to help pay for your education, the Canada Revenue Agency (CRA)allows you to claim the interest paid on your tax return.

Credit card debt

This is probably the worst kind of debt because the rates can be very high. Many rewards cards are around 20 per cent, while department store cards can be closer to 30. If you make only the minimum payment, it can take years for you to pay off your credit card debt. And you’ll end up paying back a lot more than you actually borrowed. Missing a payment or two will hurt your credit score. Make sure to pay off your balance on time every month or it may be harder to qualify for a mortgage in the future.

Investment loans

A loan to start a business or used for investment purposes is another example of good debt. Having a business on the side or a full-time basis can pay off over the long run if you’re successful or you find a buyer. Another option is to borrow to invest in a number of different types of investments, such as stocks. The CRA will usually allow you to deduct your interest costs if the investment produces interest income or dividends.

Car loan

A car loan is usually considered bad debt because the vehicle is a depreciating asset. In fact, it loses value as soon as you drive it off the lot. While a vehicle helps you get around, it’s hard to see how a vehicle improves your net worth – especially if you consider the annual cost of gas and insurance. However, a car may be a necessity if you don’t live in the city or if public transportation is difficult
to access.

Mortgages

A mortgage is mostly considered good debt because a home will likely appreciate in value. But a mortgage can be a bad debt if you buy something that’s barely affordable. While a financial institution may approve you for a large mortgage, it doesn’t mean you should spend as much as you can. Doing so will possibly leave you house poor with little left over for necessities or emergencies. A better kind of mortgage is for a rental property. Buying a home for rental purposes will give you an extra stream of income and can help pay down the mortgage faster. If the property increases in value, it will turn out to be an even better investment.

The bottom line

While good debt does exist, keep in mind that it might not be the case all the time. Whatever you do with your money, you should be responsible and don’t take on more debt than you can handle.

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