Good Debt Vs. Bad Debt: Why Not All Debt Is Bad
by CashOctopus • November 4, 2019
Debt – It’s a dirty four letter word that many of us don’t like to be associated with. Some of us fear it even more than we fear death. However, this is mostly because of a lack of understanding. Those who fear debt don’t know that there’s a difference between good debt and bad debt.
Is there such a thing as good debt?
Nobody likes the idea of being in debt. Many of us were taught from an early age to avoid debt like the plague. We grew up with the understanding that debt is a bad thing. However, life throws at us situations where we have no choice but to seek a helping hand.
If you’re feeling guilty or ashamed about having to borrow money, there’s good news for you. Not all debt is bad. In fact, some debts are actually considered a sensible investment and are therefore good debts. These are debts that have the potential to be of financial benefit to you in the future.
A debt is considered to be good when the money is used to purchase an asset that will help to build your wealth. The debt therefore has a clear purpose behind it. It also has a clear schedule for repayment. Ideally, your investment should help you generate income over time.
Some examples of good debts include:
1. Education loans
Knowledge is power. Learning is not only beneficial for gaining qualifications but also for the learning skills that can help you make a living or increase your income. Generally, people with better education have a higher chance of earning more income. Your education is therefore a good investment as it will help to increase your potential for earning more. Higher qualifications make you eligible for even more lucrative opportunities.
Be careful with this investment though. If you don’t have a clear career path or are only able to earn little from the degree you’ve chosen to pursue, your debt will become a bad one.
2. Real estate loans
Owning a home is a dream many people have. Only a few people are able to own a home without seeking some sort of financing. However, you can seek financing with confidence. Home loans are considered a good debt.
Property is known to increase in value over time. If you decide to sell your home in the future, you will most likely make a profit. Your loan will therefore have helped you generate wealth. This goes for all types of real estate.
3. Small business loan
Want to start a business? You may need some money to help you get started. A small business loan can help you set up your business and achieve your dream of becoming an entrepreneur much faster.
A business loan is considered a good loan, especially if you can turn your business into a profitable one. However, should your business fail, the loan may be considered a bad a debt.
4. Home improvement loans
Renovating your home is an investment in an asset. People like to live in comfortable homes. A renovation loan can help you achieve a more comfortable space. This in turn will help to increase the value of your home. If you decide to sell your home in the future, you will make a significant profit as a result of the renovations done on the home.
Bad debts are those debts in which the money is used for a venture that will not generate income or will not increase in value. Your debt will be considered a bad debt if you purchase an asset that depreciates over time.
Some examples of bad debt are:
1. Car loans
People need vehicles to get them from one point to another. You may need a vehicle to run errands, get to work or simply get about your everyday activities. However, purchasing a car can be costly, especially if you want to buy a new car.
Cars depreciate over time. If you opt to sell your car even after a few days, you will make a loss. There are also many other expenses attached to cars including vehicle maintenance and car insurance.
It would make more sense to purchase a car that you can afford to pay cash for. You may have to swallow your pride and buy a used car instead of the latest car that your friends have.
2. Credit card debts
Many people don’t realize that every time they swipe their credit cards to make a purchase, they are driving their debt higher. In terms of popularity, credit card debt is one of the fastest growing types of debt in Singapore. However, these debts are avoidable.
Many people tend to purchase more than they can afford. Others buy what they don’t need simply because they can. Credit cards encourage impulse buying. If you want to avoid bad debt, this is one of the first places to look.
3. Loans for consumer items
Are you going into debt to purchase items such as clothes? A loan taken to cover the cost of fast food, vacations, gas, utility bills and other services and consumables is generally considered a bad debt. The money will be spent on things that will not help you build wealth. This money could be better spent on something else.
4. Personal loans
It’s tempting to take out a personal loan, especially when you need cash quick. Personal loans can be used to cover the cost of anything from medical expenses to the purchase of a home appliance.
These loans are unsecured loans. They therefore attract high interest rates. They are often considered bad debts as many people use the money on ventures that are not profitable. They then end up having to repay the loan plus a large amount in interest.
Not all debts are bad. Some can be considered good debts as they are beneficial in the long run. Understanding the difference between good and bad debt will help you determine whether it is worth taking that loan or not.