Debt is a common word in the lives of individuals and corporations. Debt is the exchange of money between the borrower and the lender, with an interest rate charged on the borrowed amount. Individuals and organizations take debt for several reasons. For example, suppose a student wants to pursue an education in another country but cannot pay for the expenses. In that case, he may take a loan from the bank or any other lender.
A loanee takes a loan for many reasons. A person takes a loan because they are going through a debt crisis. The reason for someone to take a loan is to expand their business.
Similarly, organizations take out loans to expand their businesses.
The debt must be returned on a later date, as decided at the time of the borrowing. The amount borrowed minus the payments that have been made is called the principal. Along with the principal, the borrower must pay interest monthly or annually. Debt may be good or bad. This article discusses the several types of good and overwhelming debt and helps readers make smart debt choices.
Good debt
Good debt helps increase the borrower’s net worth, generate income, and help achieve a sustainable future. One of the most common good obligations is an education loan. Getting a good education from a reputable institute means learning from a seasoned faculty and studying in a competitive environment; therefore, one is well-prepared for the professional challenges ahead. Quality education is also associated with well-paid jobs and more employment opportunities. The college degree will soon pay for itself; therefore, the loan is worthy. Such debt is good debt. A mortgage is another good debt as it is used to finance a house. The value of real estate-grown exponentially, and having shelter is one of life’s basic needs. Therefore, a mortgage is good debt because of its increase in value in the future and opportunities for earning income via rent. One must look for investment opportunities such as buying shares or property that will increase an individual’s net worth and finance them through debt if required.
Severe debt
Debts that are used to purchase depreciating assets are insufficient. The value of such support does not grow in the future. Instead, it depreciates. These assets do not contribute towards earning income for the borrower. One of the joint bad debts is an auto loan. Buying a vehicle is expensive and costs a lot of money. However, people have become accustomed to traveling in their cars and consider it necessary in today’s world. Paying interest on a vehicle does not add to the borrower’s value, not generating income. Also, the car depreciates over time, and it is valued for less when resold. Therefore, auto loans fall under the category of unmanageable debt. Another joint lousy debt is credit cards. The interest rate charged on credit cards is extremely high and higher than that of consumer loans. The customers must pay a lot of extra money and the borrowed amount. Therefore, the balance on a card is unmanageable debt.
Differentiating good debt and unmanageable debt
Borrowing money is difficult because the borrower is always worried about paying back the loan as soon as possible. However, borrowing a loan is not still good or bad. Suppose an individual or a company borrows a loan to invest in an asset that will earn profits. In that case, borrowing is a desirable choice. Such borrowings, called good debt, add to the borrower’s help.
On the contrary, some borrowings are used to buy things that may add comfort but do not add to the borrower’s assets. Such borrowings, called lousy debt, become a liability for the borrower. One must avoid taking horrible debt as it adds to the financial burden and does not contribute to the borrower’s net worth and income. The interest paid on lousy debt is not worth spending because there are no returns to the investment.
Takeaways
- Manage your debts with full responsibility if you want to enjoy all its benefits.
- Severe debt refers to the lack of capacity to repay
- You must have the skill to avoid poor credit
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