AS I always advocate for savings and investment, hence encouraging people to take a loan will be my last preference.
My ultimate slogan remains to be a ‘debt free lifestyle’, but in reality things are quite afar and thus I have to recognize the presence of ‘debt’ in our day-to-day life. Whether we like it or not but for sure ‘debt’ has become an integral part of our day-to-day life.
Nowadays, there are so many easy loans available in the market and people are falling prey to them quite recklessly. So if ‘debt’ is an unavoidable factor in our life then we have to find ways to deal with it such that we can guard ourselves from ill effects of the ‘debt’ or at least minimize its adverse impact.
This is where I want to introduce categorization of the ‘debt’ into good debt and bad debt. While on this it is important to clarify that here the use of the term – good debt and bad debt is not on the lines based on which bank classifies its loan portfolio.
We all know that in the banking parlance, the ‘bad debt’; means those loans which are outstanding for a long time and thus unrecoverable. Contrary to this, for a bank ‘good debt’ means a loan which is being serviced by the borrower as per the payment schedule, and without any default.
Leaving aside the banking terminology, the term good debt and bad debt mentioned in our today’s article carries a different meaning. Here these terms are used from an individual’s perspective to understand the difference between a good debt and bad debt.
Thus before you sign on the dotted lines [for taking a loan], pause for a moment to determine whether the loan you are taking will turn out to be a good debt or bad debt. How do we know which debt transaction is going to be good for us and which ones will be bad, and thus to be avoided?
There are many factors which need to be considered to determine this classification of the debt. Naturally, debts are neither good nor bad; it all depends on how you use them in your life. If used well, debt can help you succeed financially to live a fulfilled & dignified life.
And conversely, if the debt is not used well then it can make someone’s life as ‘hell’. This is where you can see the importance of classifying our debt requirements between good and bad. A good use of debt is when you borrow to purchase an appreciating asset such as land, house or to stock your business.
Such debts help you to make money, record growth in your business leading to betterment of your life. Similarly you can also borrow money and invest in your life by paying for a professional course, attending seminars, or buying self-help books.
This is another form of investment on which you will reap rich dividends in the days to come. So education loans whether for self or any family member are to be considered as good debts provided the end beneficiary takes the education seriously?
It can’t happen that you have taken a loan to send your child to an overseas university where the Child instead of concentrating on the education indulges is wasting money on unnecessary material things. A debt is bad when you borrow to buy a depreciating asset or to finance a lifestyle that you can’t afford.
It is not good to borrow to buy things like telephone handsets, cloths, home improvement and other luxurious goods. If at all you have to borrow, then do so to satisfy your “needs” and not ‘wants’. A car, a computer and other machines may be an asset or a liability depending on how you use them.
If you use them as a working tool, then they will aid you to make more money else they will stand as a liability on your income. Remember, ‘good debts’ often can turn into bad debts if misapplied. This is where discipline and wisdom comes in.
Most of the people who are in debt today took them with good intentions but things did not go as planned. You need to be very cautious when taking debts because they are like a double-edged sword. They cut both sides and if you do not handle them by the ‘handlebar’, then they will severe cut your hand.
Another important factor which you should consider while taking a loan is ‘cost of capital’ and ‘return on capital’. If you can generate returns on the deployed capital at a higher rate than the implied ‘cost of capital’, then this will be a perfect example of a ‘good debt’.
So always keep the end utilization of the debt money in mind. If your debt do not conform to this rule, then regardless of the purpose, you are either straining or you are at the risk of straining and running out of control to plunge into a debt trap.