Understanding Good Debt vs Bad Debt in Canada
Learn to differentiate and understand good debt vs bad debt in Canada.
8 minute read
Originally published: May 31, 2023
Understanding Good Debt vs Bad Debt in Canada
Learn to differentiate and understand good debt vs bad debt in Canada.
8 minute read
Originally published: May 31, 2023
Debt is often viewed as a dirty word, but not all debt is created equal. Understanding the difference between good debt vs bad debt is crucial for Canadians looking to make informed financial decisions.
Good debt can help you achieve your goals, like buying a home or investing in your education, while bad debt can quickly spiral out of control and lead to financial ruin. In this guide, we’ll explore the characteristics of good debt and bad debt, and provide practical tips to help you manage your debt and build a strong financial foundation.
Whether you’re a first-time homebuyer, a student with student loans, or simply looking to improve your financial literacy, this guide will equip you with the knowledge and tools you need to make informed decisions about your debt.
In this article:
What is Good Debt?
Good debt is any debt that helps you build wealth or increase your net worth over time. While you still have to pay interest on good debt, the return on investment is typically higher than the cost of borrowing. Good debt is often associated with investments in assets that appreciate in value over time, such as real estate or education.
One example of good debt is a mortgage. A mortgage allows you to buy a home and build equity over time. As you pay down your mortgage, the value of your home may appreciate. When you sell your home, you can use the equity to purchase a new home or invest in other assets. Additionally, mortgage interest is tax deductible in Canada, which can help reduce your tax bill.
Another example of good debt is student loans. While it may be overwhelming to graduate with student loan debt, investing in your education can pay off in the long run. On average, Canadians with a bachelor’s degree earn $24,000 more per year than those with only a high school diploma. Over time, this higher earning potential can more than offset the cost of student loans.
Finally, business loans can also be considered good debt if they are used to invest in a business that has the potential to generate a return on investment. For example, if you take out a loan to purchase equipment for your business, the return on investment from that equipment can help pay off the loan and increase your profits over time.
The benefits of good debt include:
- Building equity
- Increasing your net worth
- Higher earning potential
- Tax deductions
- Potential for return on investment
What is Bad Debt?
Bad debt is any debt that does not increase your net worth or generate a return on investment. Bad debt is often associated with high-interest consumer debt, such as credit card debt or payday loans. Unlike good debt, bad debt can quickly spiral out of control and lead to financial ruin.
One example of bad debt is credit card debt. Credit card debt is often associated with high-interest rates and fees, which can make it difficult to pay off. Additionally, credit card debt is not tax deductible and does not generate a return on investment.
Another example of bad debt is payday loans. Payday loans are short-term loans with extremely high-interest rates. While payday loans may seem like a quick fix for financial emergencies, they often lead to a cycle of debt that is difficult to break free from.
Finally, car loans can also be considered bad debt if they are used to purchase a car that depreciates in value over time. While car loans may be necessary for some Canadians, it’s important to consider the long-term costs of car ownership before taking on debt.
The consequences of bad debt can be severe and long-lasting. Some consequences of bad debt include:
- High-interest rates
- Fees and penalties
- Reduced credit score
- Difficulty obtaining credit in the future
- Collection calls and legal action
How to Manage Bad Debt
If you have bad debt, it’s important to take steps to manage it before it spirals out of control. One strategy for managing bad debt is to consolidate your debt into a single loan with a lower interest rate. This can help reduce the overall cost of your debt and make it easier to pay off.
Another strategy for managing bad debt is to prioritize your debt payments based on the interest rate. Focus on paying off high-interest debt first, such as credit card debt or payday loans. Once you’ve paid off high-interest debt, you can focus on paying off other debts.
If you’re struggling to manage your debt, consider seeking the help of a financial advisor or credit counselor. They can provide you with personalized advice and resources to help you get back on track.
Tips for Avoiding Bad Debt
The best way to avoid bad debt is to be proactive and make smart financial decisions. Some tips for avoiding bad debt include:
- Create a budget and stick to it
- Avoid impulse purchases
- Use credit cards responsibly
- Build an emergency fund
- Invest in assets that appreciate in value
- Prioritize debt payments based on interest rate
The impact of debts on your life insurance policy
If you have debts, they can have an impact on your life insurance policy. In some cases, your debts may reduce the amount of coverage you can secure. This is because insurance companies take into account your debts and other financial obligations when determining your eligibility for coverage.
However, securing a life insurance policy can also help alleviate the financial burden of debt. By using your life insurance payout to pay off your debts, you can leave your loved ones with a clean slate and avoid passing on any financial obligations to them.
How life insurance can help pay off debts:
Using life insurance to pay off your debts is a strategy that many people find helpful. The payout from your life insurance policy can be used to pay off any outstanding debts you may have, including credit card debt, student loans, or a mortgage.
This can be especially beneficial if you have high-interest debt, such as credit card debt, that can quickly accumulate and become unmanageable. By using your life insurance payout to pay off this debt, you can avoid paying high-interest rates and save yourself a significant amount of money in the long run.
Types of life insurance policies that can be used to pay off debts:
There are two main types of life insurance policies: term life insurance and permanent life insurance.
Term life insurance provides coverage for a set period of time, typically 10, 20, or 30 years. This type of policy is generally more affordable than permanent life insurance and is a popular choice for those looking to secure coverage for a specific period of time.
Permanent life insurance, on the other hand, provides coverage for the duration of your life. This type of policy is generally more expensive than term life insurance but offers additional benefits, such as cash value accumulation and the ability to borrow against the policy.
Both types of policies can be used to pay off debts, but term life insurance may be a better option for those looking to secure coverage specifically to pay off debts.
Frequently Asked Questions (FAQs) about Good Debt vs Bad Debt
Examples of good debt in Canada include mortgage loans, student loans for education, and business loans for investment purposes. These types of debt have the potential to generate long-term benefits and positive returns.
Good debt typically involves borrowing for investments or assets that have the potential to increase in value over time. Bad debt, on the other hand, refers to borrowing for non-essential purchases or depreciating assets, often carrying high interest rates and offering little long-term value.
Good debt can offer several benefits, such as building equity in property or investments, increasing net worth, providing opportunities for higher earning potential, offering potential tax deductions, and potentially yielding a return on investment.
Accumulating bad debt in Canada can have severe consequences. It often leads to high-interest rates, additional fees, penalties, and a reduced credit score. Moreover, it can make it challenging to obtain credit in the future and may result in collection calls or even legal actions.
Life insurance can play a significant role in managing debt while you’re alive. By having a life insurance policy, you can provide financial protection for your loved ones in the event of your death. If you have outstanding debts, such as a mortgage or loans, life insurance proceeds can be used to pay off those debts, relieving the burden on your family and ensuring they are not left with significant financial obligations.
When you pass away, any outstanding debt you have does not automatically disappear. However, if you have life insurance coverage, the death benefit can be used to settle your debts. The proceeds from the life insurance policy can be directed towards paying off mortgages, loans, and other financial obligations, alleviating the burden on your loved ones and potentially preserving their financial stability.
Using Good Debt Wisely and Avoiding Bad Debt
Understanding the difference between good debt vs bad debt in Canada is crucial for Canadians looking to make informed financial decisions. Good debt can help you build wealth and increase your net worth, while bad debt can lead to financial ruin. By prioritizing good debt and avoiding bad debt, you can build a strong financial foundation and achieve your financial goals. Remember to seek the help of a financial advisor or credit counselor if you’re struggling with debt, and always make informed decisions about your finances.
Since 2007, Protect Your Wealth has been a trusted source of expert guidance in life insurance, retirement planning, and investment strategies. As your dedicated life insurance broker and financial planner, we understand the importance of creating a customized plan that safeguards your family or business while meeting your specific needs.
Contact Protect Your Wealth today at 1-877-654-6119 to learn more about your options! We’re proudly based out of Hamilton, and service clients anywhere in Ontario, British Columbia, and Alberta, such as Toronto, Victoria, and Edmonton.
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