Good Debt vs Bad Debt

Introduction

Debt is a financial decision that keeps a borrower in financial stress for a certain period. Hence, it’s a human tendency to consider each debt a bad debt. It is a misconception that lies among people. We can classify debts into two categories based on whether it is contribute to achieving long-term significant financial goals.

The two basic debt categories are good debt and bad debt. This blog will help you understand both concepts with examples. Also, we will see how you can avoid bad debt.

What is Good Debt?

Good debt is financing in ways that help you meet your short-term and long-term financial goals. It eventually builds a pathway to your long-term financial abundance. Some examples of good debts are listed below.

Interest-Free Loans: Interest-free loans are allocated for certain types of purchases. Non-profit organizations support the education of students and business ideas with an interest-free loan.

Refinancing Existing Debt: When you choose to pay off existing debt at a high cost of borrowing by taking out a loan with a low cost of borrowing. It’s a smart strategic move that can help you reduce the total amount you are going to pay for that existing loan.

Business Loans: Building a business often requires a large amount of financing for sustainable growth. It also requires good lines of credit and additional business loans if needed. It is considered a good debt because it helps you build a system that pays you and your employees. Once you hit the breakeven point, you can relax and easily complete the loan that helped you build your financial source.

Student Loans: It would not be false to consider student loans or, say, education loans as an investment for personal and career development. A student loan is financing you can get to support your education. On the other hand, private student loans sometimes provide you with a loan at a high cost of borrowing, which can be a little frustrating.

Home Loan or Mortgage: Having your own home is one of the significant milestones everyone dreams of. While buying a house can be costly, a mortgage loan provides a good source of financing to fulfil your dream of having your own safe space. A home is a real estate investment that builds equity.

What is Bad Debt?

Bad debt is generally a result of a lack of financial knowledge and impulsive decisions of the borrower. Such decisions do not help one achieve financial freedom. It can be understood well by the following examples.

Credit Card Debts: Credit cards are a financing option that comes with the high cost of borrowing. Whether you are shopping or just casually roaming around, if you like something, you can quickly purchase it with a credit card. But if you are habituated to impulsive buying, you can be stuck in long-term debt. Not considering paying off the credit card debt can make you pay a higher cost of borrowing.

High-Interest Loans: Whenever you have not researched before going for a loan, you may end up taking out a high-interest loan. It is also considered a bad debt.

Debt for Impulsive Buying: Lenders do offer small loans for emergency purchases. When small personal loans are used for vacations, buying expensive clothing, hobbies and other just-for-fun expenses, it is considered bad debt.

Frequent Payday Loans: A payday loan is a good option when you are really in a financial crunch and your next salary day is still not here yet. But, if you are going for a payday loan often, it can be considered as bad debt because of the high cost of borrowing.

Difference Between Good Debt & Bad Debt

Criteria	Good Debt	Bad Debt
Purpose	Used to acquire assets that increase in value or generate income	Used to purchase depreciating items or non-essential goods
Examples	Student loans, mortgages, and business loans	Credit card debt (for non-essentials), payday loans
Return on Investment	Potential to generate future financial benefits	Little or no financial return
Interest Rates	Usually lower, may be tax-deductible	Typically, high interest rates
Impact on Net Worth	Can increase net worth over time	Often decreases net worth
Duration	Often, long-term, structured repayment plans	Often short-term, with pressure for quick repayment
Risk Level	Lower if planned and managed properly	Higher due to lack of return and high costs

How You Can Avoid Bad Debt

Creating bad debt is simply a lack of knowledge and bad financial habits. But you have control over the way you make financial decisions by implementing small changes in your everyday financial behaviour with these tips.

Create a Budget

Creating a budget and tracking your finances helps you be aware of how you are using your money, what your needs are, and what expenses are for temporary impulses. This way, you can implement saving habits and reduce unnecessary expenses from your financial behaviour.

Research

Before making an impulsive financial decision, take time to do a small research about it. Make a comparison between the good financial offers. Choose the ones which support your dream of financial abundance.

Start Emergency Savings

You would never regret saving money. Whenever you need money in emergencies, especially those small emergencies where you ask your family or friends for financial help, having savings can help you be financially independent.

Build Good Credit

While you are paying your debts, consider monitoring your credit score. See what you need to execute to take your score to good heights. Each financial decision you make for your debts impacts your credit score.

How To Be Free From Debt

1. Prioritize Debt Payment

   Always prioritize paying off your debts in your monthly budget. Time-to-time payments would also help you climb good credit score. Additionally, your future self will be thankful to you for your wise financial behaviour.

   
   

2. Smart Manage Your Existing Debts

   As we discussed earlier, paying off a high-cost debt with a small cost of borrowing debt is a smart move in your financial journey. If you have multiple debts right now, you can make a list of them and plan your payment-off strategies accordingly.

   
   

   Also, considering paying the high cost of borrowing a loan first can help you be financially relaxed. Paying the loans with a small cost of borrowing first can make you feel a financial achievement and boost your confidence.

   
   

3. Take Financial Advice

   You can also take help from financial experts who can suggest better ways to manage your debts. Also, they can help you plan your budget and suggest the best improvements that can speed up your financial stability.

Conclusion

It is not about getting a loan to spend however you want, it is more about your financial behaviour. Educating yourself financially is the primary factor that holds potential to lead you towards your long-term financial goals.

Stay tuned to our website for more information on financial education.

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