Are you considering borrowing money? Many assume that all debt is bad, however, taking on debt for the right reasons can positively impact your financial health. We call this “good debt.”
How can you know whether debt will be beneficial or negative? We’ll outline the differences in this article and how to manage debt efficiently.
Good Debt:
Good debt is low-interest rate debt that increases wealth or income over time. This type of debt can be seen as an investment in your future, enhancing your assets or financial situation. Some examples of debt that provide financial benefit over time include:- Student Loans: Gaining further education can leads to higher earning potential
- Mortgage Loans: Buying a home or store front can appreciate in value and build equity
- Business Loans: Securing a low-cost loan, like an SBA 7(a) loan, to expand your business can lead to growth and increased profits
Bad Debt:
Bad debt is borrowing that does not contribute to financial growth or improvement. It often comes with high interest rates and low financial returns. Examples of bad debt include:- Credit Card Debt: Collecting high-interest debt from purchasing non-essential items, such as luxury goods, vacations, or dining out does not directly contribute to your future financial well-being.
- Auto Loans for Expensive Cars: Financing a car that rapidly depreciates and is beyond your financial means does not improve your future creditworthiness.
- Personal Loans for Lifestyle Expenses: Borrowing for things like weddings, vacations, or expensive hobbies that do not generate income or increase in value will not improve your future financial profile
How to Manage Debt:
Whether your debt is “good” or “bad” it is crucial to manage your debt responsibly to avoid any negative impact on your financial health. Some strategies to ensure you are in control of your debt are:
Create a Budget: Track your income and expenses to understand your financial situation. With any existing loans, know how much you owe. If you need to repay outstanding debt, it can be helpful to identify areas where you can cut costs.
Prioritize High-Interest Debt: Focus on paying off debts with the highest interest rates first to reduce overall interest payments.
Make Consistent Payments: Ensure you make at least the minimum payments on all debts to avoid penalties and additional interest.
Debt Consolidation: Combine multiple debts into a single loan with a lower interest rate to simplify payments and reduce costs.
A key metric you can track to help you get a better grasp of your financial situation is your debt-to-income ratio (DTI). This metric measures your ability to manage monthly debt payments. You can calculate your DTI ratio by taking your total monthly debt payments and dividing it by your gross monthly revenue.
For example, let’s say your total monthly debt payments are $1,500 and your gross monthly income is $5,000. Your DTI would be (1500/500) * 100 = 30%. Lenders generally consider a DTI ratio below 36% to be good. However, the lower the DTI ratio the better!
Managing your debt responsibly can improve your credit score, reduce financial stress, and increase your ability to achieve long-term financial goals.
Good Debt for Small Business Owners
If you are a small business owner seeking good debt to improve your financial health, consider the SBA 7(a) loan program. Whether you aim to consolidate existing debt or need extra working capital, an SBA 7(a) loan can help you grow your small business.
SBA loans are government-backed, long-term, and low interest loans for small businesses. Through NEWITY’s streamlined application, you can discover how much you can receive in less than 10 minutes. The application is risk free and will not impact your credit score.
