Understanding Good Debt vs. Bad Debt

Good and Bad Debt

Debt. It’s one of those words that has an inherently negative connotation. In fact, it often gets a bad rep. For the most part, we as consumers believe that all debt is bad debt. But that’s not entirely true. Not all debt is created equally, and when it comes to building your credit history — and raising your credit score — some types of debt are more beneficial than others.

Of course, being too deep in debt is never good, no matter what types of credit accounts you have. Let’s take a look at some of the types of debt that can actually be a boon to your credit score and credit history.

What’s in the ‘good debt’ category and why?

Good debts are those that help you establish credit and show that you are financially responsible. For example, a mortgage loan that is paid on time each month is one of the main credit accounts that can help you to build up your credit. Mortgage loans, which are repaid over 15, 20, or 30 years, show longevity in financial responsibility. Because payment history accounts for 35 percent of your credit score, the longer you have a loan and make timely payments, the better it reflects on your score.

Debt that helps you to generate income or increase your net worth is also viewed as good debt. Student loans fall into this category, for example. Education in general increases a person’s potential for better employment opportunities and higher earnings. An investment in a degree is likely to pay for itself within five years or less of the loan recipient entering the workforce. Over the course of a lifetime, there is a huge potential for significant ROI on that educational investment.

Of course, to make a student loan a positive on your credit, it’s imperative to make all payments in full and on time until the loan is satisfied.

Oldies, but goodies

For the same that long-term loans like mortgages are good for your credit, old debt also falls into the category of good debt. Again, this goes back to payment history. Still, many consumers mistakenly believe that they should close a credit account the minute it’s paid off. So, before you call the bank or credit union to close that car loan account you’ve just paid off, keep in mind that closing an established account just because it’s paid off can actually drag your credit score down.

As long as the account has a good payment history associated with it, it will have a positive effect on your credit score. Remember, the longer your history of good debt, the better.

As John Ulzheimer, a nationally recognized credit expert formerly of FICO and Equifax put it, getting rid of old good debt “is like making straight As in high school and trying to expunge the record 20 years later. You never want that stuff to come off your history.”

Credit cards can also fall into the good debt category, so long as they carry low interest rates and you don’t max out the balances. Overall, your credit card balances should never be higher than 30 percent of the total credit limit available. Once they exceed this level it can start to drag your credit score down.

Diversity is also good

No matter how much or little debt you carry, it’s important to have a mix of credit accounts in your name because credit account diversity accounts for 10 percent of your credit score. Smart planning shows financial responsibility, and spreading out your spending is a great way to illustrate this. Lenders want to see your experience with numerous credit types.

Just be sure that you don’t overextend yourself with too much open credit or too many payments to maintain. Payments can add up quickly when you have multiple loans and credit cards. Many consumers quickly get in over their heads and end up damaging their credit. If you are struggling with how to fix bad credit, you can benefit from talking to a respected credit repair company.

At Lexington Law, we offer a free credit report summary and consultation. Even if you don’t need credit repair services, an evaluation can help you to understand what’s contained in your credit report and determine which accounts are helping — or harming — your overall credit score. Contact us today to get started.

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