The concept of owing someone has been around a long time, as far back as the first barter-related trading in 3500 B.C., when a Sumerian farmer borrowed extra seeds to expand his crops.
While the farmer's entrepreneurial spirit was rewarded with a harvest windfall, the guy down the street who had a thing for fancy robes was swimming in debt he owed the local seamstress.
He couldn't afford a roof over his head, and his only claim to fame was being the best-dressed homeless guy in Mesopotamia.
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Not All Debt is Created Equal
Spending money you don't have doesn't necessarily sound like a good idea, but like the farmer who reaped the rewards of going into debt over extra seeds, some debt is actually good. Quite good, in fact. Having some debt can actually help your credit score. A catch-22, but yes, debt is needed to raise your credit score. And if used correctly, debt can actually help you build wealth.
There's no better example of the old adage "it takes money to make money" than good debt. Good debt helps you generate income and increases your net worth. Bad debt, on the other hand, is using borrowed money to purchase an item that typically decreases in value or merely satisfies a short-term want. A perfect example of bad debt is credit card debt. Our well-dressed homeless Sumerian guy would have been all over the credit cards.
Modern life requires many of us to borrow money at some point or another. But knowing the difference between good debt and bad debt can make a big impact on your financial health and chance of success. It is best not to incur more debt than you can comfortably afford to pay back, regardless of whether it is good or bad.
Also, don’t let debt add up to more than 36 percent of your total gross income, as credit agencies do not differentiate between good and bad debt when determining your credit score and credit-worthiness.
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Top Four Examples of Good Debt (Think BERI)
Making money is the whole point to starting a small business. Roughly two-thirds of millionaires are entrepreneurs. As long as you have a detailed business plan, the know-how to run your business and a great idea, the debt you took on should eventually pay off itself and then some.
Investing in education is smart. In general, the more education an individual has, the greater the person's earning potential. Over the course of a lifetime, educated workers are likely to rack up a return on investment measuring in the hundreds of thousands of dollars. So while student loans are one of the biggest chunks of debt many Americans have (with an average of $29,000), it doesn’t mean it’s a bad thing. If your student loans got you your high-paying job, then they are viewed as a way to help increase your earning power.
There are a variety of ways to make money in real estate. Because home values are expected to increase each year, taking out a mortgage is considered to be a good debt. This is especially true if you are taking out a mortgage on a second home to use as an investment property.
Many would argue that the home you live in is not an asset, but a liability. Since people move every seven years on average, this logic would hold true. If you are going to view your home as an asset, it’s best to stay in the home until the mortgage is paid off and either stay in it or sell it and downsize. Having a mortgage will also help boost your credit score (assuming you make all of your payments on time).
Short-term investing provides an opportunity to generate income, and long-term investing may be the best opportunity most people have to generate wealth. The wide variety of available investments from traditional stocks and bonds to alternatives investments commodities, futures and precious metals (just to name a few) provides an array of choices for just about every need and every risk tolerance.
Some debt can be good. Just make sure it's attached to a long-term goal that will generate earning power. Remember, choose your seeds wisely and pass on the fancy robes. Unless of course, you're starting a business to make incredible, fancy robes.