Smart debt vs. dumb debt

Using your credit wisely can help you reach your financial goals, but if you are impulsive and extravagant, you can go deep into dumb debt.

One of the most critical elements of learning to manage your finances is knowing the different between smart debt and dumb debt.

Dumb debt
This is the kind of debt you rack up from making impulsive purchases that you cannot afford. Dumb debt often comes as a result of trying to keep up with others. It’s the kind of debt incurred from the instant gratification of making excessive and unnecessary purchases. It only sets you further back financially and does not help you build assets or reach your financial goals.

While much of dumb debt comes from credit card spending, not all credit card purchases are dumb debt. In fact, using a credit card can help your credit score, because you are building a favorable credit and payment history. But if you can’t manage your payments and you are strapped for cash each month trying to pay your credit card bill, you are going into dumb debt and you need to rethink your spending habits.

Dumb debt does not just come from credit cards. You can also rack up dumb debt by buying a house you can’t afford because you’re offered low monthly mortgage payments. It can also come in the form of a seven-year car loan on a car you’ll only drive for a five years. Or it can be consolidating your debt on a home equity line only to rack up even more debt when your credit cards are paid off.

Smart debt
Smart debt is the kind of debt that helps you financially. Mortgages and student loans can be smart debt, if you get the right loan and manage your payments well. Having a mortgage helps you build equity in your home, giving you an asset that you own. Student loans help you further yourself educationally, resulting in more opportunity in your career. And if you put a substantial down payment on a car and pay off the loan in a few years, that can be smart debt. Using your credit card can also be a smart decision, as long as you pay off your purchases in full each month.

Knowing the difference between smart and dumb debt is important. Resist the urge of dumb debt so you can reach your financial goals with smart debt.