Good Debt Vs Bad Debt

Being in debt at some point in life is almost inevitable for most people. 

Unless you are born with a silver spoon in your mouth, there will be times when a person needs to borrow money (for education, college tuition, for home or in case of an emergency).

Although most people tag debt with sheer negativity, sometimes it could be a smart choice to revamp your life completely. If you take a closer look, debt often has a positive flip side. With good loans, you could add a specific value to your life. Certain things like education, home etc. are smart purchases to a happy and financially abundant life. 

In this article, we will be dealing with the concept of Good debt and Bad debt and how a seemingly innocent good debt could turn into a blood-sucking vampire and how to avoid it.

What is good debt?

Good debt is defined as a loan that will eventually help you to generate more income to increase your net worth. Good debt is an excellent investment for a promising financial future.

When it comes to good debt, you will have an exact reason for taking it and a realistic plan for paying back the amount very soon without entangling yourself into a financial mess.

Someone who is planning to be in a good debt will have discovered the cheapest option to borrow the money and would have carried out extensive research on the interest rate, methods of borrowing, terms of payment etc.

Let us take a look closely into some of the different types of good debts.

1. Mortgage 

This is probably one of the most justifiable causes for getting into debt. Mainly due to two reasons. Firstly you need a place to live, and secondly, you will have an asset which will last for a long time.

Studies have shown that in several parts of Malaysia, housing prices continue to rise at a steady scale. The good thing about mortgages is that once you have finished paying, you will have an asset that is usually worth far more than what you have borrowed.

Mortgages usually have lower interest rates when compared to other forms of debt. Furthermore, it is a suggested approach to save money rather than spending it on rent every month.

2. Educational loan

Educational loans provide support for those who aspire to gain a higher college degree.

With better education, a person’s future is more likely to improve and be secured as the chances are high that he might end up in a high paying job.

Before planning to take an educational loan to enrol in the course of your choice, it is better to carefully examine the pros and cons of the degree of your particular interest.

If there is a lack of demand or a job opportunity coming up with the course that you are studying, chances are most likely that a good debt could turn out into a bad one.

3. Loans for Business

Investing in a business can be a great idea if you have a smart business plan. Small business loans are hard to get as the extent of risk is considered high from the perspective of the lender.

Research has shown that almost one-third of small businesses fail to survive their initial two years. If you are ambitious to build a business with a smart plan in place, borrowing money to start with will be an excellent investment.

4. Real Estate

Studies have shown that the Malaysian real estate industry is slowly picking up a good pace.

It is no surprise that many people are rushing to invest in the real estate market. Make sure that you have thoroughly researched the pros and cons before investing. Without a thorough knowledge, any good investment can turn into a bad debt quickly.

What is bad debt?

A loan that continually drains your wealth, is not affordable and offers no likelihood of paying for themselves in the future is a bad debt. These are the ones which decrease in value after you have bought it.

You might be surprised to know that most of the purchases you make for life’s necessities such as household equipment, your brand new LED TV, game console etc. are part of bad debts. 

One interesting thing about bad debt is that in the long run, you will lose more money which can eventually lead to bankruptcy proceedings being initiated by your creditor. These come up after a court judgement is obtained against you/your firm declaring you financially incapable of paying the debts. 

Now this is not just a bad name earned for yourself but also a tough legal situation to get out of. 

So, unlike the good debts, bad debts have no realistic plans for repayment, and most of the payments are made impulsively.

Here, a person who is borrowing money will have no certainty whether he will be able to repay the money or not. Examples of bad debts:

1. Credit card debts 

When used correctly, credit cards could be a life saviour, like in the case of an emergency. Credit card debt often becomes bad debt when you use it to make large purchases and pay a minimal amount every month. It can be even worse if you delay the payment after the due date resulting in a high-interest rate and not to mention a bad score on your credit report.

2. Automobile loans

For most people having their car will help to save a lot of waiting time in their life.

But you need to be careful before planning to purchase a new car. Ask yourself the question, are you stable in your job? Can you afford to pay back the amount? Is it possible for you to balance the monthly expenses?

Brand new cars lose their value after a certain period, and for certain brands of vehicles, the resale value is meagre.

The interest rates of automobile loans are relatively low, which is one of the main factors that attract people. The most financially prudent move is to choose a car which fits your budget and avoid going for an expensive one.

3. Borrowing money to pay the bills

If you are caught up in a vicious cycle of constantly borrowing money to get to the end of the month, it is guaranteed that you are soon going to be entangled with really bad debt.

Financial counselling will help you to make fine adjustments to ensure that you could effectively manage your finances.

Tips to get out of a debt as soon as possible.

1. Spend less than what you actually plan to spend

Most people find themselves in debt, mainly because they purchase things beyond their normal ability. If you want to buy something, don’t purchase it unless you have money to buy it.

2. Pay more than the minimum

While you are paying back the monthly credit amount, always make sure that you pay more than the minimum payment. For people who only pay the minimum amount, it will take forever to close the debt.

If you want to pay back the balance quickly, you should pay as much extra as you can afford.

3. Close the most expensive debt first

If you are someone with a vast list of debt, it would be wise to focus on the debt which is charging you the maximum interest.

It doesn’t mean you should avoid paying back other debts, but instead focus on the most important one and clear it off as soon as possible. Once you have finished paying it, focus on the second most important one, followed by others.

4. Keep a thorough check on unnecessary spending

Keep a track on all your spending in a month and identify the areas where you tend to spend more. This not only helps to give you an understanding of your spending habits but also to identify the areas where you can save.

5. Get a second job

This is an ideal way to pay back your debt at a quicker pace. The extra income that you earn through your second job will help you to be free from debt in a short number of years.

Bottom line

At some point in life, everyone has to deal with debt. What really makes a difference is your planning to prevent the good debts from becoming bad debts.

By carefully analyzing your financial picture, you can decide an effective way to pay off your debts. Ideally, it is better to focus on paying back the bad debts first since they are costlier and provide no value.

Finally, make sure you never end up in too much debt, even if it’s a good one. If you are overburdened with debt, it doesn’t matter whether it is good or bad, it will still hurt your financial health.

Get in touch with a debt counselling agency to understand how you can pay back your loans without getting into serious financial and legal troubles. 

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