How Do You Know if You're "in Debt?"

Did you know that there is a difference between good debt and bad debt? It's true, and unfortunately, most Americans fall in the bad debt category. Many people assume that all debt is bad, but actually some debt can increase your wealth. Let's learn about the differences.

Good debt is a debt that will increase your wealth. Perhaps the best example of good debt is a home mortgage. For example, let's say that Joe took out a loan for a $100,000 mortgage. He is now $100,000 in debt, but he has invested in something that will only increase in value. Perhaps when his loan is paid off, he will own something that is worth $200,000. This is a perfect example of taking on debt to increase wealth.

On the other hand, bad debt is investing in something that will only depreciate in value. High interest credit cards are a perfect example of this. If you used a credit card to pay for a $75 sweater from a department store, that sweater would worth about half of that when you walked out the door. But, if you made minimum monthly payments on it at a high interest rate, you could pay four times that before it was paid off. That's bad debt.

The Difference Between Secured and Unsecured Loans

You should also understand the difference between secured and unsecured loans. A secured loan is a loan that is given "against" something. For instance, when you buy a house or a car it is a secured loan. These loans generally have lower interest rates, because the lender isn't taking that big of a risk. (If you don't pay your loan, they will take the object that secures it.)

But with an unsecured loan, the lender has no guarantee, and therefore charges more interest. For example, all credit card loans are unsecured, which is why you pay such an exorbitant interest rate for them.

Do you want to find out whether you have good debt or bad debt? Read the following list, and then look at some of our other articles to determine what you can do to get your credit under control.

Do you have a home mortgage? (That's good debt)
Do you have a car loan that is more than you can afford? (That's bad debt)
Do you have high interest rates that are all charged to the maximum? (That's bad debt)
Do you have a few credit cards that you use for small purchases, but pay off as soon as you get the bill? (That's good debt)
Do you have loans for things like investment properties or businesses? (That's good debt)

So, how did you do? If you find that you have more good debt than bad debt, that's great news! If you found you had more bad debt, you should take the steps to completely eliminate all of your bad debt now. For a reality check on how bad debt can really add up, download our Credit-Card-Cop and see just how much money you could save down the road with the interest you're paying now.

Summary

Bad debt is unsecured, meaning there is no tangible object that can be repossessed if you are unable to make payments
Good debt is secured by a tangible object of equal or greater value
Because bad debt is unsecured, it carries with it a higher interest rate
Examples of good debt include a home mortgage, property investments and small credit-building credit cards
Examples of bad debt include extravagant auto loans and unpaid credit card debt

If you found out that you're in bad debt, it's time to look at one of your options for getting rid of your debt as quickly as possible, in What is Debt Consolidation and How Does it Work?