Debt is a common word in the lives of individuals and corporations. Debt is defined as 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, if a student wants to pursue an education in another country but is unable to pay for the expenses, then he may take a loan from the bank or any other lender. 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 is called the principal.
Along with the principal, the borrower has to pay interest monthly or annually. Debt may be good or bad. This article discusses the types of good and bad debt and helps readers in making smart debt choices.
Good Debt:
Good debt is a debt that helps increase the net worth of the borrower and generates income and helps achieve a sustainable future. One of the most common good debts is an education loan. Getting a good education from a reputable institute means that one has learned from a seasoned faculty and studied in a competitive environment. Quality education is also associated with well-payed jobs and more employment opportunities. A college degree will soon pay for itself, so the loan is worthy. Such debt is good debt. A mortgage is another good debt used to finance a house. The value of real estate grows exponentially, and having a shelter is one of the basic needs of life. A mortgage is good debt because of its increase in value in the future. One must look for investment opportunities such as buying shares or property that will increase the net worth of an individual and finance them through debt if required.
Bad Debt:
Debts that are used to buy depreciating assets are bad debts. The value of such assets does not grow in the future. Instead, it depreciates. These assets do not contribute towards earning income for the borrower. One of the common bad debts is an auto loan. Buying a vehicle is expensive and costs a lot of money. Although people have become accustomed to traveling in their cars and consider it a necessity in today’s world, paying interest on a vehicle does not add to the value of the borrower does not help generate income. Also, the car depreciates over time, and it’s valued for less when resold. Auto loans fall under the category of bad debt. Another common bad debt is credit cards. The interest rate charged on credit cards is high and higher than that of consumer loans. The customers have to pay a lot of extra money along with the borrowed amount. The balance on a card is bad debt.
Differentiating Good Debt and Bad Debt:
Borrowing money is a difficult decision to make because the borrower is always worried about the ways of paying back the loan as soon as possible. A loan is not always a good or a bad idea. If an individual or a company is taking out a loan for investing in an asset that will earn profits, then borrowing is a good choice. Such loans, called good debt, add to the assets of the borrower. But some loans are used when buying luxuries that may add to the comfort but do not add to the assets of the borrower. Such loans, called bad debt, become a liability for the borrower. One must avoid taking bad debt as it adds to the financial burden and does not contribute towards the net worth and income of the borrower. The interest paid on bad debt is not worth spending because it gets no returns to the investment.
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