Since time immemorial, debt has been looked at as a scary little four-letter word which feels like a crushing weight hanging around your neck. Currently, very few people are totally debt-free by choice. And for others it’s a simple part of their lives. It’s how they pay for everything… from homes, cars, apparels, gadgets, groceries etc. In simple terms, debt is money owed by one party, the borrower-debtor – to a second party – the lender-creditor.
Before one borrows money, it’s important to understand the difference between good debt and bad debt. Evaluate your debt to figure out what kind of debt it is so that you can prioritize paying it down or use the money for other useful purposes. Here’s how you can tell the difference between good and bad debt and save yourselves from financial mess in future.
In simple words, a good debt is a debt that is practical investment which is made for your financial future. This good debt will help you in the long term and will not have negative effect on your total financial position. To achieve your financial goals, one has to spend money to make money. If you don’t have money, you borrow it as a debt. One must have a clear and specific reason for borrowing money and post that have a sensible plan for paying it back. This process allows you to clear the debt as quickly as possible.
One must educate and make themselves aware of the various interest rates, loans or credit amounts and figure out the rates best suitable for them.
A few notable examples of good debts are:
- Education Loans: Education is equivalent to being prosperous in life. The more degrees an individual gets, the better chances the person’s earning potential also gets. Better educated employees are employed in good paying jobs and also get good opportunities in future.
- Real Estate: Residential properties can also help to generate more income by renting it out. Even commercial properties are the source of continuous cash flow.
- Business Investment: A loan can help you set up your own business. It helps you be self reliant as well as not live life from paycheck to paycheck.
By bad debts we mean debts which exhaust an individual’s wealth and are also not affordable and propose no real prospect of paying up in future. They don’t help you generate income nor does it go up in value. Few notable examples of bad debts are:
- Cars: If you don’t need to buy a new car, rethink your options. Buying a new car is always expensive and they have a depreciating value attached to it.
- Luxury Vacation: A luxury holiday is a dream for a lot of individuals. But it is best avoided if you don’t have the budget or a plan to repay the loan. Rather than getting into a debt, try to save as much as you can for the trip so that you don’t have to bear the brunt of financial disaster in future.
- Credit Cards: Credit cards are the worst bad debts ever. The credit card companies charge hefty interest rates on every single thing you purchase. Stay clear of credit cards debts at all costs. If you have already got them then prioritize and pay them off.
In future, whatever you do make sure you have a plan for what you are going to do with the money. Always give your money a purpose and avoid making the common financial mistakes that will pull your finances down.