Credit is credit right? You get a loan and you pay it off? Well, no, the truth of the matter is that credit is much more nuanced than that.
In finance, there is a world of difference between credit that can be considered ‘good’, and of benefit to you, and ‘bad’ credit that can be very harmful.
Let’s spend some time and look at the deep and often times confusing world of credit. We’ll pick apart the different types of credit and examine situations where you may want to avoid credit altogether.
Isn't All Credit Bad?
We’ll push away the notion that al credit is necessarily bad for starters. It’s easy to think so, after all, you are borrowing money that you don’t have, in order to pay for something that you essentially can’t afford.
How could we ever move away from this world view of credit?
Good Credit Can Be An Investment
In our current world economic system, we operate under s system, essentially of credit.
Money is borrowed from one place and invested in another.
Of course there are winners and losers, but this is essentially what is happening, and how money flows through the system.
Governments borrow money all the time. Consider government bonds – your government borrows money from institutions and large investors. They then take this money and build the systems and infrastructure that will, hopefully, make the country more profitable in the long run.
This is an example of good debt. Of course, the system can be misused, and there are many who would question this economy, but in the language of finance, this is a good debt.
Essentially, growth occurred that wouldn’t have happened if money had not been borrowed.
Now consider other times when money is lent, with an eye to the future.
Did you take out a student loan?
Have you, or are you considering buying a house?
Both are examples when you borrow money to do something that would be otherwise impossible.
Your education pays off with a better job, and house prices, generally, go up so your investment ends up being worth more.
And Now To Bad Credit
So, if good credit, good debt if you like, is a means to obtain something of more worth in the long run, I think you can guess what bad credit is.
Bad credit can take many forms.
Bad credit is borrowing money in order to purchase something that will nor gain in value in the long run.
Borrowing money to buy a new car could be considered a poor investment. You will pay interest on the loan, and when the loan is paid off, the car will not be worth what you paid for it.
Any situation where the interest payments are not covered by the growth of your investment is a candidate for bad credit.
Other situations would be using a credit card and only paying the minimum monthly payment, or going overdrawn on your bank account to buy luxuries that you didn’t need.
In both cases, the resultant product does not cover the loan cost.
To Sum Up
Always make sure you are borrowing money for the right reasons, and that your investment will pay the interest on the loan.
Don’t forget that poor borrowing decisions will also have a significant effect on your credit rating.