With the rising cost of living, it’s almost impossible to live without debts today. Sometimes debt might feel like the only way out of a financial problem. However, before taking that loan, you need to understand the difference between good debt vs bad debt.
Some items are worth taking a loan for, while others will leave you in a huge financial crisis, which will take you years to recover. Here is what you need to know about good debt vs bad debt.
Good debt is money that you borrow to secure your financial future. You are using it to fund something positive in your life. You should have a specific and clear reason for borrowing it.
You should also have an effective way of repaying it as soon as possible. If you are taking a loan, you should have also identified the lenders offering the best terms, rates and fees.
Some examples of good debts include student loans, mortgage, a business loan and investing in real estate. However, while good debt may appear like a great idea, it doesn’t offer any guarantees.
Your plans may not work out as intended. As for education, you are not always assured of landing a great job after graduating. Also, if you invest in a small business, there is a risk of failure. On the other hand, investments in real estate, mutual funds and stocks usually depend on market conditions.
Bad debt refers to money you borrow to fund unnecessary expenses. Its return on investment is almost nonexistent. You are simply borrowing it for gratification or to appear wealthy in the eyes of your friends or colleagues.
Also, you may not have a realistic repayment plan and it may leave you in a serious financial crisis. Some examples of bad debt include borrowing money to buy cars, clothes and other consumables.
As much as you may require a car to run your errands, buying it on loan is a waste of money. Vehicles lose value immediately you leave the lot. Therefore, shelve your ego and buy a used car at a cheaper cost.
Also, avoid luxury holidays that you can barely afford. Some people also borrow money to pay off credit card debts. Such debts are also considered as bad financial habits.
The Gray Areas
There are also certain debts that fall between good and bad. Such areas have generated a lot of controversy over the years. Some of them include borrowing to invest, consolidation debt and credit card reward programs.
For instance, borrowing money at a low interest rate and then investing at higher returns may appear like a prudent financial move. However, it comes with numerous risks especially if you are not an experienced investor.
Loan consolidation also falls in the gray area. Some financial experts will urge you to consolidate while others will caution you against it.
Final Thoughts On Good Debt Vs Bad Debt
Before you borrow money or take out a loan, take some time to differentiate between your needs and wants. Determine whether the money you are borrowing is going to leave you with a positive or negative financial situation.
Ultimately, how you use the money you borrow will determine whether it’s a good or bad debt.