Good Debt & Bad Debt
Which to accept—which to avoid

It's very difficult to remain totally debt-free. Most of us cannot afford to be debt-free because there are some debts that are better to have than the alternative. Let's consider a home loan vs. renting. Renting is a no-win situation. You simply throw your money out the window paying the land lord. Buying a home puts you ahead since you are investing in real estate where the property appreciates in value.

Consider this real-life situation. You buy a home for $100,000 with a $5,000 down payment leaving you $95,000 to finance. Your monthly payments would fall around $820 per month which includes your principle, interest at about 6% APR, escrow for your yearly property tax and mortgage insurance. After 7 years your home's value appreciates to $135,000. Subtracting the initial loan amount leaves you with $40,000 in home equity—money you would get back if you were to sell your home (and that's not including the amount you have already paid into the mortgage that would be added to that amount).

	Opt for a home equity loan instead of a regular loan when it makes more sense and when you have your debt with reasonable control—it's tax deductible saving you more money.

In order to get a comparable home to live in on renting terms, you'd be paying roughly $750/month or more. Then each year the land lord adjusts your rent for inflation adding another $20 to $30 per month each year. You could very well be paying $1,000 per month by the 7th year of rent. Fixed rate mortgages don't go up (except for taxes). You can at times lower your mortgage payment when refinancing makes sense. Do the math:

Mortgage: 7 years of payments would cost about $69,000 and you get back $40,000 plus whatever payments you have paid into the principle of the loan if you sold at the 7 year mark.

Renting: (with a rough average monthly payment over 7 years at $875) would cost about $73,500, but you don't get a dime back.

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A home will be your best investment. And since mortgages are generally cheaper than other forms of debt, it makes that sort of debt more acceptable. On top of that you can deduct the interest you pay on the home loan up to the first $1 million of a mortgage loan. Home remodeling can be a good investment since it will add value to your home (provided you don't over-extend yourself in debt).

Another investment that you likely can't live without is a car. Because of that it's considered good debt. Although not necessarily a great investment, a very reliable new car can certainly help you to get to work on time so you can keep your job. You may be tempted to take out an equity loan for your car. Be sure to calculate the costs carefully. If you default on the equity loan, you could lose your house. Equity loans are great in that you can deduct the interest paid into them, but many times it makes more sense to get an auto loan instead.

College education is another one of those valuable assets considered good debt. Get college loans and other types of loans and grants that don't get tied to your home equity. Again an equity loan looks tempting due to the benefits of tax deduction and lower rates, but it's as if you are putting your home up as collateral to ensure that the student loans get paid off. A regular student loan many times makes more sense.

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Financial experts conclude that your debt should not exceed 36 percent of your gross monthly income. Your ratio is factored into your credit score and how much more debt you can safely take on and whether or not you get other needed credit should you need it.

Credit card debt and other short-term loans are generally considered bad debt. Bad debt is OK to take on if you can safely afford it and pay it off responsibly. Credit cards make it very easy to spend more and lose control of your finances. Current sources say that the average household has about $8,000 in credit card debt and that bankruptcies are happening at alarming rates.

If you are to take on bad debt, generally it's better to keep those sorts of purchases tied to a short-term loan with low rates, fast cash loan or even charge it to a low interest rate credit card where you ensure that you pay more than the minimum monthly billing. If you want to use your higher interest credit card, you'll want to eliminate that debt as soon as possible without depleting your cash reserves for emergencies.

While it's probably not possible to avoid all debt, realize which debt is acceptable, how much to assume in debt and keep a savings on hand for emergencies. Good debt is debt you assume for things that you need. Going on a ship cruise to the Bahamas might seem like fun for the moment, but a month afterwards may leave you regretting the trip once the extra bills come in. Perhaps a more localized trip for vacation would make more sense and help you to stay within your budget. Pay for the expensive trips when you have plenty of funds on hand.

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