What is debt? Simply put, anytime you owe someone money for anything you are in debt, be it a cell phone payment for two years, a car, store credit, or mortgage for a house. Anytime you owe money, you have created debt.
What is good debt or bad debt?
There are three schools of thought on what constitutes good debt and bad debt.
- Good debt increases your net worth while bad debt decreases your net worth.Essentially, this means that debts that are used to purchase appreciating assets are considered good debts (i.e. primary home) whereas debts that are used to purchase liabilities or depreciating assets are bad debts.
- Good debt is a debt that creates income in excess of it’s repayment. In this scenario, a primary home would not be considered a good debt because it doesn’t ordinarily create income.
- There isn’t anything such as good debt. They believe all debts are bad but some are tolerable. They believe debts used to purchase appreciating assets and income producing assets are tolerable but should also be avoided if possible.
Debt poses risk that we cannot quantify, whether it is bad debt or good debt (no matter how you define it), there are too many uncertainties in the future to accurately predict risk. On the other hand, the right amount of leverage (debt) can help increase returns and take advantage of opportunity cost. It is important to use debt sparingly and carefully. No matter the opportunity cost or the potential reward, there is still an unquantifiable risk of leverage.
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