How To Tell If You’re Making A Good Debt Or A Bad Debt

When you tell a person that you’re currently working on paying off a debt, you’d probably get a subjective stare right away. People may even pity you, thinking you’re incapable of making rational decisions when it comes to your finances and you might probably be swimming against the high tides of disastrous debt.

Yes, it’s true that not all debts are good – and yet not all of it is bad. In fact, when used smartly, your debt can actually help you supercharge your wealth in the long run.

Here’s another reality: only a few can earn sufficient money to pay cash for their necessary expenditures, like home, car, and education. They prove that living debt-free is indeed possible. But for some, they have to buy credit or take out an important loan at some point to cover for their purchases.

The critical part is whether or not the debt incurred is a good one or a bad one – and it boils down to the purpose of the debt.

debt-symbol

Good Debt

“Take money to make money” – this is the principle of good debt. Any loan used to purchase an asset that grows in value, helps you generate income, and helps you increase your net worth is a loan well-taken.

3 Ways You’re Making A Good Debt

Borrowing for education (student loans)
A good education is an asset that can never be replaced.

Investing in a person’s potential also pays in the long run. If you’re educated, you can find greater employment opportunities in the future. Same goes with taking post-graduate courses to enhance your abilities and knowledge about your chosen field. You could contribute more to the company, increasing your value as an employee and raising your potential future income.

And it can be cheap too. Compared to other types of debt, student loans have a very low-interest rate.

Borrowing to buy real estate property (mortgage and home equity loans)
Not everyone has sufficient monthly income and savings to purchase a home. However, you don’t have to wait for your earnings to triple before you can finally move to a new home. This is where a mortgage comes in handy.

Taking out a loan to buy a real estate property is one of the best debts in terms of costs and returns of investment. Firstly, home mortgages generally have lower interest rates than other debt and they are tax-deductible as well. They are also long-term loans, which you can pay for 30 years but with relatively lower monthly payments.

Secondly, you can take a tenant in and rent out a part of your residence to gain profit.

Lastly, you can make passive income since your home is an appreciable asset. It increases in market value over time. Buy a house, live and nurture it for decades before selling it, and gain double or triple profit.

Borrowing for a small business ownership (business loans)
Borrowing money to start a small business is also a smart move. You’ll earn without relying on a third party to hire you and hand you a paycheck monthly. You are your own boss. With adequate knowledge, perseverance, good game plan, and a bit of luck, you can turn your dreams into a self-sustaining enterprise.

In the same way, you could also use loans to develop your established business with the high hopes of gaining more profit. You could invest in new equipment, maintenance and aesthetics of your place, and advertising to drive potential customers.

Bad Debt

Now let’s talk about the debt that’s likely to dig deeper holes in one’s pocket. If you’re taking out a loan to purchase assets that won’t go up in value or quickly lose their worth, and won’t generate income, then you’re probably making a bad debt. High-interest loans are also regarded as a bad debt.

3 Ways You’re Making A Bad Debt

Car loan

An auto loan can be considered a good debt if the car you’re going to purchase is essential to your business, like becoming an Uber driver or operator.

But if the car is meant for personal use without the intention of making money out of it, then taking a car loan can be a bad debt. Paying interest on an expensive car is a waste of money since vehicles are depreciating assets.

Credit cards
The idea of being able to afford the things you love with just one swipe seems enthralling – until you’re faced with a credit card bill. Credit cards are one of the reasons why several people are mired in bad debt. Firstly, credit cards tolerate poor spending habits. Secondly, their payment schedules are often set to maximize costs for the card holder. And lastly, they carry very high-interest rates.

With this, you have to assess the urgency of the purchase before you use a credit card. Needless to say, it’s not sensible to use it for consumable goods like groceries, fast food, and gasoline, clothing, and vacations. The general rule is if you can’t afford it, don’t buy it; if you can’t repay it, don’t take it in the first place.

Payday loans or cash advance loans
These high-interest loans, like credit card loans, are designed to cover an emergency expense. In a payday loan, you as a borrower will write a personal check to the lender (containing the amount owed plus a fee) and you’ll have until your next payday to pay it back, plus the interest incurred. It’s expensive, especially when you default as you’ll have to pay another processing fee to roll over the loan.

The only good reasons why payday loans still thrive: they are accessible and lenders don’t require you to have an impressive credit history to qualify.

Author Bio:
Ina Salva Cruz is one of the daytime writers for Speedy Money Payday Loans, an Australian-based business, providing short-term borrowing solutions. Like other young adults, she’s focused on getting a head start on her finances and she loves to write about wealth-building tips for millennials.

 

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