Good Vs Bad Debt

Financial knowledge awareness, knowledge and management is essential so as to ensure that you take actions that may build your wealth. However, at times we may need some extra funding in the form of loans. Is there good debt or bad debt? So as to understand these concepts, do read on.

Which debt is good?

Which debt is good?

  • Good debt

This is a debt which is considered positive, as it is expected to give you returns or earn you an income. An example of this is mortgage loans. Such debts can also be tax deductible, as is the case when the amount of the loan repayments is higher than the income from rental payments. This makes the borrower entitled to negative gearing.

  • Bad debt

Bad debt is that which is spent on the purchase of items that do not appreciate in value over time. In addition to this, it does not earn you any income nor is it tax deductible. Examples of such debts are using loans or credit cards on entertainment, luxury items or to take a holiday. Bad debt is also one which is taken so as to cater for

  • Which debt is good?

The argument posed has always been that good debt is good, whereas bad debt is bad and that it worsens an individual’s financial standing.

Good debt offers individuals good financial prospects in the long-term. This is the case when one invests in their business, borrows a loan for a car that they can afford, takes up a student loan or takes a mortgage. Good debt should not be used to pay off another debt as it leads to more costs in terms of interest, instead you should go for consolidation loans.

Good debt offers good financial prospects

Good debt offers good financial prospects

Bad debt can be used wisely when the credit card debt is paid by the end of the month to avoid being charged higher interest fees. Generally speaking, bad debt is good only when you can pay it off in the short term.

However, purchase of luxury items would be considered as excessive spending. It is not a good financial decision and neither is it an investment. The use of bad debt requires discipline as one should not exceed their credit limit.

The access to a pool of funds tempts individuals to spend more than they should, leading them to further indebtedness. Credit cards also have a high interest rate, which takes a hit on one’s financial position.

Good financial decisions involve the purchase of items that appreciate in value. It is clear that it is only good debts that offer you with such assets and returns. A sound investment is only possible with good debts. Good debts are also payable over a longer period of time, whereas bad debts have a higher interest rate and need to be paid using one’s next expected salary, as is the case with payday loans or credit cards.

They often lead to a vicious cycle of indebtedness as one may need to borrow more money so as to meet their needs or to pay off the loan. Bad debts are enticing as they offer quick and easy access to funds but they have detrimental effects in the long run. Make wise financial decisions and keep away from debt. If you really need to borrow money, make a good decision and let it be good debt.

Card Debt Trends

Credit cards give the borrower access to a pool of money. They get to borrow money which does not exceed their credit limit. The cost of living is on the rise and so is the cost of debts as well as the update of loans by most individuals. As an individual’s cost of living becomes higher than their flow of income, they will seek out sources of funding so as to get by. There are various options available ranging from payday loans, peer to peer loans and debt consolidation to credit cards.

credit card debts

credit card debts

The use of credit cards is common among many individuals across the world. This also applies to most citizens in the USA. The numbers seem to be on an upward trend with each passing year.

As per the data recorded in the third quarter of the year 2015, US consumers owed credit card debts that amounted to $712 million. The average amount of credit card debt owed by each US household was $15355.

Data related to the nominal income and the cost of living was recorded over a period of 12 years (2003-2015). Between 2003 and 2008, the median household income had a steady percentage increase which was higher than that of the overall cost of goods. At some point in the year 2008, the increase in the percentage of both the nominal income and the cost of living were at par.

Thereafter, the percentage change in the cost of goods has been on a gradual increase over the years. On the other hand, the percentage change of the nominal income has been fluctuating, having a downward trend between 2008 and 2010. From the years 2010 to 2015, the percentage change of the median household income has been steadily increasing, but at a rate lower than that of the overall cost of goods.

In as much as the number of credit card users and the amount of debts owed seem high, there is a possibility that the figures may be higher. This is because most individuals are usually shy to state the amounts of debt that they have. It is likely that most borrowers state half the amount that they owe while others may not know the total amount of their debt.

The following reasons indicate why the cost of debt loans is increasing:

  • The credit card interest amounts to $2500 or higher

Consumers incur an average cost of $2,630 annually on interest charged on their credit cards. This is calculated with the assumption that the Annual Percentage Rate is 18%.

  • The cost of debt increases as one’s income increases

credit limits

credit limits

High income households have the advantage of getting higher credit limits. However, this is not the case of low-income households. Therefore, the higher the amount of the credit card debt that a low-household income incurs, the higher the percentage of the amount owned up by the debt on their annual income.

The spending of higher income households will not affect their finances as much as it does to lower income households.

These card debt trends prove that in as much as the credit card is a popular means of getting funds, the impacts are negative and lead to further indebtedness. The interest rates are higher than any other type of loan and the rates seem to be on a constant upward trend. Take charge of your finances and do not be part of the borrowers counted as statistics in credit card debt.