Can you tell the difference between good and bad debt?

By: Bogie Boric Personal Finance 1 Follower


0 Votes
5969 Views

Is there such a thing as good debt? Yes. Is all debt bad? No. Debt is simply the obligation to repay an amount for services or purchased property funded by another.

 

Bad debt is debt that strains personal financial stability. Credit cards can be valuable in establishing credit history but they are often misused. Maintaining credit card balances under 30% of your available credit limit will increase your FICO score.

 

FICO is a rating system that takes credit card balance to credit limit ratio into account along with timely payments. The FICO rating accounts for approximately 65% of your credit score as reported by the big three credit reporting agencies.

 

When applying for loans your potential creditor will review your overall credit history along with your credit rating and FICO scores. Using your credit card wisely can raise your credit rating substantially.

 

Paying your credit card balance down as little as 10% can raise your credit score as much as 5 points. Reduce your debt to credit limit ratio to 30% and you may see as much as a 20-50 point jump in your overall credit score.

 

However, creditors look beyond your FICO score and your overall credit rating. Creditors take a long hard look at your good debt. Good debt is secured by a substantial asset such as a home or car.

 

Debt associated with a home mortgage is one of the best types of debt. A solid history of home mortgage payments along with low overall debt to income ratio will enhance your chances of qualifying for many types of online loans.

 

Home mortgages or car loans are just two examples of good debt. Other good debt can include student loans or business loans. However, your payment history is just as important if not more on your good debt as your other debt.

 

Establishing a good credit history with unsecured debt shows potential creditors you can be trusted to repay your obligations. Repaying secured obligations in a timely fashion shows potential creditors you can handle large loans.

 

Your payment history, debt to income ratio and balance to credit limit is often the only information loan officers or creditors offering online loans will have to base their decision. If your scores fall within the creditor's parameters for approval, you will be awarded the loan. If not, you won't, as there are no gray areas with online loans. Creditors look for applicants with responsible credit usage.

 

Start small with a credit card with a relatively small credit limit. Open a credit card with a credit limit of less than $1,000. Maintain an average balance of $300 over a period of six months to one year. Your credit score will improve providing you continue to make all payments on time.

 

Making your monthly payments on time and occasionally going beyond your invisible credit ceiling, then paying it down in one or two months will also demonstrate financial responsibility.

 

Conversely, a credit card with a $300 credit limit carrying a balance of $200, regardless of timely monthly payments, will dramatically decrease your credit score. Creditors look at ratios and your ability to monitor and control your credit card balances on unsecured debt.

 

Another thing to consider is that the interest you pay on your debts will always be higher than interest you gain on your savings so if you have funds in a savings account or cash ISA then it may be worth your while using this to pay down your debt.

 

The most important point to take away from the good debt versus bad debt controversy is not which debt is good or bad. Avoid ugly debt by making every payment on time, at or above minimum payment requirements. Debt can go from bad debt with unreasonable debt ratios to ugly debt with just one missed or late payment. The only true good debt is a debt well managed.

Vote

0 Votes

You May Also Like...

Join the Discussion

Kimmy Burgess
Advisor: Kimmy Burgess, Personal Loans
Nice article Bogie. You should know the difference between good and bad debt. Bogie explain it very well. Always do your homework before starting any type of stuff.
Thanks for sharing this article.