Loans are a powerful financial tool that helps you achieve all your small and big aspirations and goals. And with the digitisation of the financial industry and competitive interest rates, getting access to credit has become easier than ever. But does this make the debt good?
Many people avoid taking any form of credit because they believe ‘any debt is bad debt’. And although this is not necessarily false, it’s not 100% correct either. So, is there really such a thing as good debt and bad debt? The short answer is- yes. Let’s dive into both these concepts to understand what they mean and how you can differentiate good from bad debt.
What is good debt?
Good debts help you purchase assets that either depreciate slowly or grow with time. Think of it as a form of credit that can help you build your net worth. Although good debt is debt after all and can strain your finances initially, it can help you accomplish your long-term financial goals and secure your financial future. Let’s look at some examples of good debt.
- Student loan
Getting a student loan can be a financial burden but the purpose it serves, in the long run, makes it worth it. How? A student loan helps you learn relevant skills and get a degree, increasing your income potential. It is a form of debt that helps you improve your finances over time.
- Home loan
Buying a home is a significant investment. However, it’s an asset that will help you secure the financial future for yourself and your family. If the value of your property rises in the future, you can sell it to make a profit. You can also use your home as collateral to avail of loans from financial institutions.
- Small business loan
If you’re planning to launch a start-up or expand an existing business, taking a small business loan will be a smart move. It is good debt because it helps you grow the business and increase revenue. When your business becomes profitable in a few years, it makes the initial debt worth it.
Remember, good debt can quickly turn bad if you borrow more than what you require and fail to repay it.
What is bad debt?
Bad debt is a form of debt that hinders your financial wellbeing. When you take a loan to buy something whose value doesn’t increase with time, it is bad debt. It does not contribute to achieving your long-term financial goals. Here are a few examples of bad debt-
- Credit card debt
With the ‘buy now, pay later’ concept, it can be tempting to put all your expenses on a credit card. But the interest on credit cards is exorbitant and if not repaid on time, it can push you into more debt. To avoid this, make sure you keep track of your credit card bills and repay them on time.
- Auto loan
Taking a loan to buy a car is a bad debt because, by the time you repay the loan, its value depreciates. If you want to sell your car after some time, you’ll not necessarily get a great deal. So, if you do need to buy a car, get a loan with low interest rates. This way you can commute conveniently without burdening your finances.
- Personal loan for nonessential expenses
Taking a personal loan to buy designer shoes or an expensive TV is not only a bad debt but also an unhealthy financial habit. Not only do these purchases depreciate with time but you end up paying interest on their actual value. Therefore, instead of taking a loan for these expenses, try to increase your savings for a few months.
Although some forms of debt are bad debt, they are not always avoidable. So, make sure you borrow only what you can repay and opt for loans with low interest rates. Before taking any credit, ask yourself questions like-
- Do I absolutely need it?
- Can I afford it?
- Is this the right time?
And lastly, make sure you stick to your payments regularly and pay off the debt in time.
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