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.
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 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.
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.