Not All Debt Is Bad: 3 Times Getting a Loan Is a Smart Idea
by Christy Bieber | Updated Aug. 30, 2021 - First published on Aug. 25, 2021
Can debt really be a good thing?
In many cases, borrowing money is considered something to avoid. After all, if you take out a loan, you have to pay interest -- which is an added cost. You're also committing future income to making payments, which gives you less flexibility going forward.
But despite the common misconception that borrowing is always bad news, the reality is that there are situations when getting a loan is a good thing. Here are three of them.
1. When your loan improves your net worth
Sometimes, you can borrow for something that will actually make you wealthier over the long-term.
One of the best examples is a mortgage. A mortgage comes with a very affordable interest rate, and interest can even be deducted from taxes if you itemize when filing returns. Plus, it allows you to buy a house, so you can start building equity, stop wasting money on rent, and hopefully benefit from rising property values.
Another good example is a business loan. If you can borrow money at a low rate in order to start a profitable business that increases your earnings, doing so could be a smart decision.
You'll want to consider the cost of borrowing versus the future value of the asset you're acquiring with the loan to decide if debt is good or bad for you.
2. When your loan makes debt payoff cheaper and easier
Say, for example, you owe a lot of money on credit cards that are currently charging 20% interest. If you could qualify for a personal loan to pay off your credit cards with an interest rate of 9%, taking out that new personal loan could cut your rate in half. And the effect could be even more dramatic if you take out a personal loan to pay off your payday loans, which can sometimes have interest rates topping 400%.
If you can get a new loan at a lower rate than your current debt, refinancing could be a really smart financial move. And if you use your new loan to pay off multiple debts, this level of debt consolidation could actually make repayment both cheaper and easier since you'll be going down to only one low-interest monthly payment.
3. When your loan helps you build credit
Lenders like to see a mix of different kinds of credit on your credit report. This means you'll have a better score if you have some loans with fixed repayment schedules along with credit cards. Because of this, you may want to take out a small auto loan when buying a car and just pay it off quickly even if you could afford to pay cash for the vehicle. Or you may want to take out a small personal loan at a low rate to finance a purchase and then focus on paying it off ASAP.
There are even some specific types of personal loans solely designed to help you build credit, such as credit builder loans, which cater to bad-credit borrowers who might not otherwise be able to get approved for financing. These loans could help you to improve your credit score significantly, which could make future borrowing easier.
As you can see, there are several reasons why borrowing may be a good thing. The big question isn't, "Are personal loans bad?" or, "Are other types of credit bad?" Instead, ask yourself what you're doing with your debt. If you're using it as a tool to improve your situation, then it's a good thing. But if you're borrowing for the sake of financing a lifestyle you can't afford, you may want to think twice.
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