MN Business Tip Of The Day: The Good, The Bad, & The Neutral Categories Of Debt

February 4, 2014  |  

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Yes, you need to pay off what you owe. But it’s important to make the distinction between “good,” “bad,” and “neutral” debt. This knowledge will help in prioritizing what should be paid of immediately and what can remain until the bitter end.

In order to understand which is which, first start by listing everything you owe: go through your bills and pull copies of your credit reports to make sure you don’t miss any accounts. For each, make a note of whom you owe, how much, the current interest rate, and minimum payment needed. Next you’ll want to divide the debt into three piles:

Good debt helps you get ahead in your financial life (i.e. an affordable mortgage allows you to buy a home that will appreciate in value over time or a small business loan which helps you invest in new equipment to increase revenue). These debts you’ll want to get rid of eventually, but not until you’ve gotten rid of higher-priority debt.

Toxic debt comes with high or variable interest rates (i.e. credit cards, payday loans and car title loans). This debt doesn’t help you get ahead. Rather it leeches your finances and becomes a drain on your money through interest payments and fees.

Neutral debt falls between good and toxic. Neutral debt typically has low or fixed interest rates and payments. While the debt isn’t the worst, it doesn’t exactly help you grow your wealth either. (i.e. low-rate car loans, personal loans, and debt consolidation loans).

While making these categorizations, remember that debt can move from one category to the other very easily. For example, a mortgage you can’t afford moves from getting you ahead financially to becoming a drain on your wealth, or a low-rate car loan can turn toxic if you’ve lost your job and can’t pay it back quickly. In this way you want to be sure to never overdose on debt at all, even what would be considered “good” debt.

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