The Case of Good Debt V. Bad Debt

I’m sure you’ve read and heard many of the statistics and stories in the news about how more and more Canadians are getting swallowed up by historically high levels of household debt.

One of the keys to financial independence is to get rid of your bad debt and acquire good debt.

Bad debt is typically defined as debts on goods or services that you consume or debt on depreciating assets. Debts such as credit card debt or car loans are typically considered as bad debts – these are the debts Canadians should be looking to get rid of as actively as possible. If you need to use your credit card or other high-interest loan on daily items such as groceries or utilities, pay off your balance in its entirety at the end of each month to avoid interest charges.

While it might be true that a vacation under the sun allows you to be refreshed and more productive at work, you may want to consider whether you should take that vacation if it means you must use your credit card to pay for it.

Good debt is debt you acquire that actually works for you. An example of good debt is a mortgage on a rental property that generates a positive cash flow every month. Good debt is money that you borrow to purchase assets that appreciate in value or to purchase assets that generate cash flows to you; however, it is important to remember that whether good or bad, you should not over extend yourself with too much debt.

5 Steps to Eliminate Your Bad Debt and Acquire More Good Debt

• Step 1 – Stop accumulating bad debt. Whatever you purchase via credit cards must be paid off in full at the end of each month. No exceptions.
• Step 2 – Make a list of all your consumer (bad) debts. This includes each credit card, car loans, and any other bad debts you have acquired.
• Step 3 – Determine how exactly you will eliminate your bad debt. Consider setting aside a fixed amount of funds each month to go towards your bad debts, or refinance your mortgage to consolidate your high interest debts.

Chances are you’ve built up enough equity in your home to pay off your high interest credit cards and consumer loans. A trusted mortgage advisor can help determine how much equity is available and how much you can save by increasing your mortgage balance to pay off bad debts at lower interest rates.

• Step 4 – Invest in yourself. Put aside a set percentage from each paycheck or each payment you receive from other sources. Deposit that money into an investment savings account. An excellent habit to develop is to have part of your income automatically put away into a savings/investment account every time you receive a paycheck. Once your money goes into the account, NEVER take it out until you are ready to invest it.
• Step 5 – Explore the option of using additional equity in your home to increase cash flow. After you consolidate your bad debts you may still have equity left over to invest in a secure cash flow producing asset. This may not be a viable option for everyone in every market; however, when done correctly, you can bolster your monthly cash flow and speed up the elimination of your bad debts.

Now – instead of just paying creditors – you’re paying yourself for only one type of purchase: assets that give you positive cash flow each month.

By getting into the habit of carrying no bad debt and using your money to accumulate assets you will be out of the ‘Rat Race’ faster than you ever dreamed!