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Good Debt vs. Bad Debt: Evaluating Your Debt Ratio

Written by Peter Schoenrock on July 6, 2010 in Credit  |   1 comment

Have you ever heard someone talk about “good debt” versus “bad debt”? Those terms can be a little misleading, but the kinds of debt you have and how you manage your finances can reflect positively-or negatively-on your credit report. Your credit report contains a story…

Debt ratio evaluationsHave you ever heard someone talk about “good debt” versus “bad debt”? Those terms can be a little misleading, but the kinds of debt you have and how you manage your finances can reflect positively-or negatively-on your credit report.

Your credit report contains a story about what kind of debt you’ve taken on and how you’ve paid it back. You might think of the $20 you borrowed from a coworker to pay for lunch as a debt, and it is, except most creditors and credit-reporting agencies aren’t going to keep track of that.

Credit reporting agencies keep a file on you containing all your credit accounts and payment histories that have been reported to them by your creditors, lenders and public records.

Your credit file can contain up to four different types of accounts or categories of debt:

  • Mortgage or home equity loan.
  • Installment debt. This could be an auto loan or a student loan-a debt you pay the same amount toward every month.
  • Revolving debt. Credit card accounts would typically fall into this category.
  • Other types of debts. Accounts in which the entire balance is due upon demand or that have one payment due as scheduled. These could be credit card accounts in which the full balance amount is due each month, or accounts from collection agencies, child support agencies, utility companies, or student loan guarantors.

What Is Good Debt?

Some types of accounts reflect more positively on your credit report because of what they can reveal about your financial habits.

Sometimes you may need to take on debt as an investment in the future. A student loan is usually considered good debt. That home equity line to build another bedroom may be a better investment than running up your credit card debt to pay for nice dinners and extravagant vacations.

Overall, any debt can be considered good debt if you are able to pay it back on time each month, making at least the minimum payment due.

What Is Bad Debt?

Any debt can turn into a bad debt if you overextend yourself or get behind in your payments. The key is to apply for credit only when necessary and to use your available credit wisely. Essentially, bad debts are those you can’t pay on time or that use up too much of your available credit.

Let’s look at a car loan. Say you need to buy a car to be able to get to work. Are you going to take out a loan for $15,000 because you know that monthly payment will fit in your budget? Or are you going to take out a loan for $50,000 and overextend yourself for that high-end automotive experience?

Overall, bad debt is debt that is incurred to fund a lifestyle that you cannot afford. Sacrificing your long-term financial health for short-term gratification is not a wise use of debt.

Turning Your Bad Debt into Good Debt

It’s easy to say, “Pay down your credit card and make your monthly payment on time,” but we hear all too often from consumers that it can be very tough to get credit accounts under control.

The first step to any effort to improve your credit-worthiness is to stop incurring new debt. Then you’ll want to take action to improve your credit behavior.

When thinking about “good debt” versus “bad debt,” it’s more about how you use the credit you’ve been extended. You want to show that you’re using your credit responsibly.

Good debt can mean that you have a mix of credit accounts and you’ve established a history of paying back your debts as agreed. By paying down your debt steadily over time, it shows that you made a decision to finance a purchase and you’re managing the responsibility to repay the debt.

Getting into debt beyond what you can handle can be a frustrating and embarrassing situation, but if you create a plan to pay down your debt and stick to it, you’ll soon start to see your bad debt looking more like good debt

Read More:

How To Dispute Credit Report Errors
Four Things College Kids Need To Know About Credit
Four Myths About Your Credit History
Debt Reduction: Why Paying Down Your Credit Card Debt Helps Your Credit Score

The information contained in this blog post is designed to generally educate and inform visitors to the Equifax Finance Blog. The blog posts do not give, and should not be assumed to provide, personalized tax, investment, real estate, legal, retirement, credit, personal financial, or other professional advice. Before making any financial decision, you should always consult with the appropriate professionals who can explain your options, rights, and legal responsibilities, and advise you on any tax, legal, credit, or business implications that may result from those decisions. The views and opinions expressed by the authors of blog posts are their own views and may not be the views or opinions of Equifax, Inc. and/or its affiliates.

1 comment

  1. P. Robison says:

    Why doesn’t credit scores take into account divorces where debt incurred
    Because other spouse just walked away from financial responsibility?

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