The Two Types of Debt

Last updated July 10, 2018debt-consolidation-credit-score

There exist two types of debt that are different in outcome. One leads to a net loss and one leads to a net profit. Identifying these types of debt let you know what debt to take on more of and what debt you should paydown. The debt you should probably paydown depends mostly on the interest rate the debt is costing you and the benefit it provides for you.

Good Debt?

Many people like Grant Cardone have amassed an enormous amount of debt, specifically hundreds of millions of dollars worth of debt and are still alive to tell the tale. Despite the massive debt accumulation, Grant somehow turns a profit out of it. This is because the cost of the debt (the interest) is less than the money Grant makes using that money. Grant uses debt to buy real estate, and the real estate produces enough money to cover the cost of the debt and then some. The benefit of the debt is more than the interest payments. This gives Grant a profit after the debt payments are made. In the same way, one could take out a loan to put into their business, and as long as they make more money from the business than the debt payments, they will benefit as a result of the debt. We’ll call this debt “good debt”. Good debt’s paydown priority remains low assuming the interest rate is reasonable and you benefit as a result of the debt.

Bad Debt

In contrast, “bad debt” is debt that doesn’t pay you anything. The thing you bought using the debt doesn’t produce any money. This debt costs you more money the longer you have it, while not paying you anything. Generally speaking, you should pay down bad debt that has the highest interest rate. A common example is credit card debt. Once you make a purchase, the product or service doesn’t pay for itself, yet the debt grows with often very high-interest rates. This results in a net loss over time. When you finance invetsments with debt, the gain (if it’s a profitable investment) outweighs the loss form the debt, resulting in a net profit over time, as opposed to a net loss over time when financing every-day purchases.

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