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Identifying the Difference Between Good and Bad Loans

The media has been over-run with talk about mortgage and credit card defaults. Many homeowners have been scrambling to save their homes from foreclosure. Hearing all of this, we might begin to wonder whether there really is such a thing as a good loan.

Using credit is not always a bad thing. We just need to understand when it is appropriate. Loans make sense when they help us increase what we already have. For example, we can use a credit card for everyday purchases if we are buying things that are within our budget and if we are able to pay the entire balance off when the monthly bill arrives.

Using the credit card can do two things. First, it allows us to put our cash to work earning some interest while we borrow the credit card’s money for free. Second, many credit cards offer cash back bonuses, flyer miles, or other perks. There is nothing wrong with accumulating these perks if it doesn’t cost us in the process.

Another example of a good loan can be a mortgage or a home equity loan. We need to be careful here, though. We should only borrow when it is going to increase what we already have.

For example, we can pull cash out to purchase more property. Real estate has the potential to be a great investment. We can use the equity in our current home to buy a rental property that can essentially pay for itself. If time permits, we can also invest in fixers. These properties may just need a little work to significantly improve their market value.

Be careful

However, please be cautious. Only a very few properties make good investments. There are diamonds in the rough out there. It is not as easy as those workshops make it look. It requires research and doing a lot of homework to find the right properties that will build our wealth.

We should only borrow money against our properties if we know that we are able to put it into an investment that is earning more for us than the cost of the loan. Do not gamble with your home. Make sure the numbers are solid.

Bad loans

Any other reason for borrowing money would make it a bad loan. We should never use credit cards as a way to get things that we cannot afford. Instant gratification may feel good now, but the interest proves that it is not the best decision in the long run.

We should not use debt consolidation programs, home equity loans, or refinancing to pay off our credit cards so that we can run them up again. We also should not borrow against the home to remodel or buy new furniture. These large purchases should be planned in advance, and we should be saving toward these goals each month until we can afford them. That might mean doing one room at a time, but the cost will be significantly less than if we borrow money to do it.

Car loans and leases should also be avoided, if possible. Borrowing to purchase a depreciating asset is not a wise investment decision.

The loan that we need to be extremely careful with is the loan from a friend or family member. It is always best not to borrow from them. Misunderstandings and miscommunication about money can cause the relationship to fall apart. It can also damage relationships with other friends or family members who find themselves caught in the middle. If it does become a last resort, it is always best to put the terms of the agreement in writing just to make sure that everyone is on the same page.