For the average American, it's nearly impossible to get by in the modern world without taking on some debt. But, used wisely, debt can be a part of a healthy financial picture and not a chain around your neck. Keep reading to learn the difference between good debt and bad debt, what to do about old debts, and how to choose which debts to take on in the future.
What is Good Debt?
The concepts of "good debt" and "bad debt" are fairly straightforward, but they aren't black and white. Good debt is generally classified as debt that will help you to invest in your health or future, adding value in some way to your life in the long term. Taking on debt to go to college or to get specialized job training, for example, is probably going to benefit you in the long run. Business or real estate loans can also be considered good debt if you're making a calculated, sound investment. And if you're dealing with a serious health issue, sometimes you have no choice but to take on medical debt, regardless of whether you feel you can pay for it or not.
What is Bad Debt?
Bad debt occurs from buying things you don't need or don't need right away on credit, or making purchases that quickly depreciate in value, such as a new car or designer clothing. Overusing credit cards or taking out high interest loans to buy unnecessary items may damage your financial health without getting you much of anything, except instant gratification, in return.
Where's the Gray Area?
Using a credit card responsibly can increase your credit score, and some cards actually offer decent rewards, like cash-back or frequent-flyer programs. Conversely, taking on "good" debt like a student loan is not always a good idea, especially if you don't anticipate having the resources to pay it back. Consider your entire financial picture before signing up for a credit card or taking out a loan of any kind in order to make the decision that's right for you.
How to Handle Old Debts
Whether you are paying off collections, high credit card balances, or old medical debts, the most important thing is to start with what will help your credit score the fastest. Here are a few guidelines:
- High interest balances should be consolidated and/or paid off as quickly as possible.
- If you have accounts in collections, start with the most recent ones and consider taking a settlement if you can afford it. You can sometimes get a major discount on those credit card balances you racked up in your twenties. But there is a downside to taking a settlement; it will be reflected on your credit report that you paid less than the full amount you owed, so only take this option if your credit is already pretty bad.
- If you have collection accounts that have been on your credit report for several years, it might be a wise to just let them go. After seven years the debt will be written off; but if you make a payment or acknowledge the debt in any way, collections agencies can continue to go after you.
- If you have old medical debt or just a very high balance, you may have some options for forgiveness or other financial assistance. Contact the provider and inquire about their options. Otherwise, continue to pay small amounts on your debt as you can.
- Some financial advisers recommend paying off your lowest balances first, one at a time, because it helps to get some momentum going and is motivating to feel as though you're making progress.
Only you can decide on the best debt management plan for you, but the bottom line is to take action on paying off old debts, even if it isn't much, and to learn how to make better decisions for the future.
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