What is debt? It is money taken on loan to meet one’s expenses. It has become the norm for many people today to live on borrowed money – so being in debt is quite common. By itself, therefore, debt seems neither good nor bad. But if one analyses it in slightly greater detail, it will be seen that there are two kinds of debt. One is “good debt” and the other is “bad debt”
Good debt is when the borrowed money is used to increase one’s assets or bring in a greater income i.e. it adds to a person’s “net worth”. This would include using the loan amount for one of the following.
None of these are sure-fire methods of positive results from debt but if undertaken carefully and wisely, the outcome is highly likely to increase income and wealth.
- Education – When education levels rise, the person’s capacity to earn more goes up. The employment opportunities increase. There are greater avenues for promotions or even shifting to better paying jobs As a result, the return on the original loan is of a very high order.
- Starting a business – Most entrepreneurs use borrowed funds to start their business. With hard work and enterprise they can quickly start making profits on their business. So again the debt that they have taken works in their favour.
- Property – Many people buy property, maybe a house/apartment or office space or a shop on borrowed capital. This can then be rented out to get a steady flow of income or they can be used by the person to save on rent. Some years down the line if they want they can even sell off the property and make a good profit. So this particular debt also turns into an asset. Taking a loan to buy property could be tax-deductible in some cases.
- Investments – Taking a loan and investing in the stock market can also be seen as a good debt. If done wisely, this money can bring in profits or income in the short term and if it is not traded, then over the years it would mean a way of increasing wealth and net worth.
Value goes down over time
Bad debt is money taken on loan which is a waste or an unnecessary expenditure. It makes a dent in one’s total assets and is therefore a drain on resources. This would include the following where the value of what is being bought goes down over time plus these expenditures do not bring in any revenue. So borrowing money to spend on such items is a bad debt.
- Food, groceries, clothes, accessories are recurring expenses. In addition white goods like cars, air conditioners, television, refrigerators, music systems, phones, computers, cars, motorbikes etc depreciate in value over time. Or going on a holiday you cannot afford. These should be bought with income that is in hand. You should not get into debt for these items. You cannot recover the money spent on these so how are you going to repay the loan you have taken?
- Using a credit card. This is a major debt trap. The product loses value over time. The credit card companies charge exorbitant rates of interest on unpaid amounts which is a further drain on your income. So do not borrow money to pay off your credit card dues. And if possible avoid using a credit card.
Therefore get into debt, in an intelligent manner, after sufficient thought and use the borrowed money to build wealth and assets rather than spend it on items that decrease in value or give you no returns. Hence debt can be good or bad depending on how and where it is used by you.
Good debt creates value. It has a positive impact on your financial situation. Bad debt holds no promise of positive returns; it is a drain on your wealth and net worth.