Photo: Marc Royce
Debt is like cholesterol. There's a good kind and a bad kind. Knowing the difference—and managing both wisely—is the key to financial well-being.
Good debt is money you borrow to purchase an asset, such as a home you can afford. History shows that home values generally rise in step with the inflation rate, so a mortgage is good debt. Student loans are, too, because they're an investment in the future. Census data pegs the average lifetime earnings of a high school graduate at a million dollars below that of someone with a bachelor's degree.
When it comes to good debt, borrow only what you can afford to repay now and in the future. A high FICO score is great for debt management; it will help you get the best deals.
Bad debt is money you borrow to buy a depreciating asset or to finance a "want" rather than a "need." A car is a depreciating asset; from the day you drive it off the lot, it starts losing value. Credit card balances or a home equity line of credit that's used to pay for indulgences—vacations, shopping, spa days—is bad debt.
Aim for zero bad debt. If you need a car, buy the least expensive one that meets your needs. You want a vehicle you can finance with a three-year loan; stretching it to four or five years is a sign you should be looking for something less expensive. The objective is to get the loan paid off and enjoy years of debt-free driving. Leasing rarely makes sense. It's just an excuse to get a new car every few years, and it keeps you perpetually in debt. Finally, if you have credit cards that charge a high interest rate on outstanding balances, look into transferring to a card that gives you a 12-month grace period of zero interest (search for one at CardTrak.com).