The Difference Between Credit & Debt

Credit can work for or against you.

Credit can work for or against you.

Broken down into its simplest terms, credit is good and debt is bad. Some debt, however, is better than others. For example, mortgage debt and business loans are typically considered good types of debt. Credit card debt is always bad, and auto loans are usually bad. People often confuse credit with debt because credit and debt are partially symbiotic: You can’t have debt without credit, but you can have credit without debt.

About Credit

Credit cards weren’t widely available until the 1970s. Most Nesties were probably born into a world where having and using credit was part of life, as natural as getting a driver’s license. Credit drove much of America’s economic growth because it gave people the means to spend. Whatever people wanted to buy, they could do so with credit. Credit was a positive experience as long as people did not spend more than what they could afford to pay back each month.

About Debt

The trouble with easy availability of credit is that many Americans use more credit than what they can afford to pay back. This puts them in debt. The psychology of credit makes this easy to do, according to Stuart Vyse, author of “Going Broke: Why Americans Can’t Hold On to Their Money.” Your future self deals with the payments while your current self can enjoy the purchase. This can work, but only if your income stream continues when payment time comes — and that doesn't always happen. (And even if it does, the amount you owe may be way over your budget.)

Good Debt May Not Be So Good

Mortgage debt has traditionally been viewed as good debt because this investment debt should create value. Business loans are also in this category. Most people cannot afford to pay cash for a house or to expand a business, for example, so going into debt in these cases is the way to create value. But even good debt does not always work if you overextend yourself. For example, traditionally people would buy a house, it would appreciate, and equity would build. Many people used that equity for other purchases such as home improvements, to pay for their kids’ college or simply to take vacations or go on spending sprees. When the housing market crashed in 2008, houses depreciated. By borrowing against the house when times were good, many people were in trouble with their mortgages all of a sudden, sometimes owing more than the home’s actual value.

Make Credit Work for You

Credit card debt and auto loans are bad debts: As soon as you make your purchase, the value immediately goes down. In the case of credit card debt, if you can pay what you owe at the end of each month, you do not pay interest charges, and if you have a card that gives cash back or other incentives, you make credit work for you. If you use your credit to go into debt, however, and pay interest on what you borrowed, you are throwing your money away. Auto loan debt is typically more unavoidable than credit card debt: Like a house, you probably cannot afford to pay cash for a car. A good rule of thumb, according to consumer adviser Clark Howard, is not to take out a car loan longer than 48 months. Sixty-month or 72-month loans mean you will owe more than the car is worth for most or all of the loan period.

 

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