Difference between good debt and bad debt

Gaining a firm understanding of how to properly manage personal finances is a good effort for anyone to invest in. As a part of this, it's important to not only recognize the differences between good debt and bad debt, but know how to balance the two. If you can accomplish this, you can use this knowledge to pave the way to a successful financial future.

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For some people, managing finances comes naturally, but for others it is a bit of a learning curve and takes a little work. So what is the difference between good debt and bad debt?

Managing good debt

Fundamentally, good debt has a strong potential to increase your overall wealth and it establishes a starting point that can lead to future financial health. This doesn't mean carrying consistent good debt is necessarily going to lead to a healthy financial future, what it means is there is potential to create additional wealth. Liabilities falling under the good debt category are debts such as:

• Carrying a mortgage
• Real estate
• Education 
• Certain investments 

All of these lead to good assets to possess. However, prior to taking on this type of debt, the property or other investment should be carefully researched, risks identified and feasibility considered. If the debt is too heavy to carry, this is only going to likely lead to foreclosure or bankruptcy, leading to bad debt.

Managing bad debt

Opposed to good debt, bad debt not only offers no real tangible long-term value, but can also lead to higher monetary liabilities that can lead to big problems with your personal finances. Bad debt contributes to a heavy financial burden that could be difficult to emerge from; it also offers no long-term benefits. Examples of bad debt are:

• High credit card bills
• Retail store credit bills
• Auto loans

While theoretically cars can be considered as an asset, the truth is most cars significantly depreciate the moment they are driven off the dealer lot. In the long term, most cars are not considered to be a solid long-term asset. To avoid accumulating too much bad debt, it is a good idea to carefully consider the purchases made. Ask yourself questions such as, "Will this item have any resale value?" Or better yet, "Do I need this purchase?"

Let cash reign

Wherever possible, a general good rule of thumb is to operate on the cash rule. If you cannot pay for a purchase in cash with the income earned in the same month, then if it's not a necessity, you shouldn't buy it.

One of the issues that perhaps contributes to high debt in modern society is that a false impression exists that one needs to continuously carry debt in order to maintain good credit. While perhaps this may or may not have been true at one time, these days, carrying consistent debt doesn't necessarily equate to good credit ratings. It is perfectly possible to establish good credit and then live a debt-free lifestyle.

Another problematic issue is the fact that today's world operates on philosophies rooted in convenience and instant gratification. Those who can avoid falling into these two habits often find they have a much better time managing their debt and keeping to a healthy financial path.