Good Debt or bad debt, do you know the difference?   Before we can explain the difference, I have to start with another topic:  Assets and Liabilities.

What is an Asset?

A true asset is not what the bank tells you it is.   The Webster’s dictionary defines an asset as:

asset

noun  as·set \ˈa-ˌset also -sət\

an item of value owned

Note the term “owned”.  An asset is something that you own.    Keep a note that the bank may confuse you with their definition.   They will count your car (even if you have payments on it), they will count your house.  In most cases, you don’t “own” these.

I like this very simple definition that you can use to identify an asset.     An asset is something that puts money into your pocket.    In other words, it makes you money.    Using this definition, your house is NOT an asset, neither is your car (whether you own it, or lease it).   They are both liabilities.

What is a Liability?

Again the webster dictionary definition is:

liability

noun  li·a·bil·i·ty \ˌlī-ə-ˈbi-lə-tē\

: something (such as the payment of money) for which a person or business is legally responsible

: someone or something that causes problems

The simpler definition is:  A liability is something you are responsible for that takes money out of your pocket.    You can see that this is exactly describes your house.   Every month, you have to pay the mortgage, the utilities, taxes, insurance, etc.    This is all money taken out of your pocket.   You can see, even if you are mortgage free, your house is still a liability.

What is bad debt?

Bad debt is simply the debt you acquired when you purchased your liability.   The result of the bad debt is two-fold.  It costs you time and money to service the liability, such as:  taxes, insurance, etc.  It costs you money to service the interest on the debt attached to the liability.  Here are several types of bad debt:  your house, your car, credit card debt, or your cottage.

Some bad debts may be required for your lifestyle.    We all have to live somewhere, so you are probably going to need a house.   Other bad debts can be toxic to your financial future.   Credit Card debt is usually a result of buying items that you probably don’t need.

What is good debt?

Now for the difference.   If Bad debt is the result of purchasing a liability, then good debt is the result of purchasing an asset.   The asset that you purchased puts more money in your pocket than the money taken out of your pocket to pay the monthly costs of the asset – the is good debt.   In this case you may not own the asset, but because it is making you money, you don’t care.

Examples of good debt are:  debt you acquire to buy houses you rent to others or debt you acquire to run your profitable business.

So I’m not saying that you should not have any bad debt, like buying a home.   I am saying that you should know the difference between assets and liabilities and good debt and bad debt.   Most people are broke because they confuse liabilities with assets and good debt with bad debt.  If you want to be wealthy, you need to know the difference.  If you’d like to understand this even better you should visit this site from Robert Kiyosaki.

Get Wealthy,

Wealth ‘n Free Leader