Jan 17, 2021

What Is Bad Debt?

Debt has such a negative connotation that people often think any debt is bad debt. However, as you enter the world of business, you’ll quickly discover that debt can actually be positive—signaling growth and investment. 

Keep reading to help discern between good and bad debt.

What Is Good Debt?

Before you can dive into bad debt, it helps to have a greater understanding of good debt. Good debt is defined as money you owe that builds up your wealth or assets over time. For example, a mortgage can be considered good debt because a property owner is building equity that can turn into profit when they eventually sell that property in the future.

Other examples of good debt can include business loans and student loans, which can grow your credit history and boost your credit scores if you make your payments on time and pay off the debt within a reasonable period. 

What Is Bad Debt?

Bad debt refers to money you owe that won’t improve your financial situation and is often unplanned or unwanted. Credit card debt is bad debt because it can drive up interest costs and bring down your credit score. Unpaid invoices, defaulted loans, and other expenses that you don’t know how to pay for often fall under bad debt.

For example, while a business loan is reviewed, applied for, and carefully managed, an unpaid invoice can cause stress for you and worsen your relationship with your vendor. That vendor can also send your invoice to collections to recoup the money, turning your bad debt into a direct attack on your credit score.  

Can You Avoid Bad Debt?  

This is a tricky question. While it is almost impossible to plan for all forms of debt, you can budget your estimated bad debt before you create it in order to pay it off quickly. For example, a business might budget for $5,000 worth of charges on the company card each month and keep that amount on-hand in cash. This way, the bad debt gets reset and doesn’t accumulate over time. 

What Should You Do if You Have Bad Debt?

If you have bad debt that is unplanned for, consider meeting with an accountant or financial advisor to reduce or eliminate it. You might be able to consolidate your loans and credit card debt into 1 plan where you only have to make a single monthly payment. You also might be able to eliminate some expenses in order to allocate more business profits to pay off debt. 

Once you have control of your debt, you can focus on growing your business and driving profit to help pay that debt off more quickly. Taking a proactive approach to debt management will help you avoid bad debt in the future.

Understanding the basics of debt can help you launch and grow your small business. The more control you have of your finances, the better equipped you are to make strategic decisions. Consider using a tool like Sunrise to track and manage your expenses and debt.

 

About the author

Derek Miller
Derek Miller
Derek Miller is a writer specializing in entrepreneurship, small business, and digital marketing. His work has featured in sites like Entrepreneur, GoDaddy, Score.org, and StartupCamp. He’s currently the CMO of Smack Apparel, the content guru at Great.com, and a marketing consultant for small businesses.

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