We all know that it takes money to make more money. If the debt helps you to make more money, then it is good debt. For example, Education loans help you with getting a high-paying job in the future and are considered a positive. Thus, education loans can be regarded as good debt. Another example is home loans. Home loans can be used for entering the real estate market, thus making money while selling previously owned homes. Bad debt is any kind of loan that someone takes to own depreciating assets. Depreciating assets don’t generate income or go up in value over time; instead, they depreciate with time. For example, if you are taking out loans to purchase a car, clothes, or perishables, then it is bad debt. If you want to purchase a car, look for loans with very low-interest rates. Many financially illiterate people try to purchase these dinners or the newest trendy clothing items with credit cards. Credit cards have high-interest rates, and therefore, it is not a good idea to purchase depreciating items with them.
Classifying debts as good or bad:
However, it is hard to classify any debt as good or bad. The classification surely depends on a person’s financial situation. It is also important to note that certain good debts can also become bad depending upon the situation. For example, if a person decides to buy a house, they cannot afford by taking out a loan, then it can turn into bad debt. Similarly, in the case of education loans, if the student takes out loans to study for a career with limited job opportunities or low-income probability, then it is bad debt. Another mistake that people often make is paying off bad debts with good debts. Often, people mortgage their homes to borrow money for a car or other depreciating assets. This isn’t a good option as any default in the repayments of such loans can result in losing the house. One way you can ensure safety is by keeping track of your overall debt. An essential rule is to keep your EMI payments limited to 30% of your take-home salary.
Investing with borrowed money:
Investing with borrowed money is yet another case where it is difficult to classify it as good or bad debt. For experienced investors with adequate knowledge of what stocks to purchase, this kind of investing might be a good debt. However, for beginners, this sort of debt could prove to be a bad debt as they could lose money in the process. Another example of bad debt is payday loans. These loans have high-interest rates and therefore are bad loans. Even if your debt is considered good, it should be paid back as quickly as possible. Paying off your debts sooner will free you to start focusing on your finance and build wealth.
