Reasons why you should …
In this article, we will explore what is good debt and what is bad debt.
Debt is borrowed money. It is an essential tool in today’s world. Countries need it to manage the economy. People need it to buy their needs and wants.
But did you know that not all debts are the same? Debt can be your friend if used wisely or your enemy if used inappropriately.
Good debts are debts that can bring you good returns and help increase your wealth. In general, if you used debt to buy something that can produce returns and help pay off the debt, then it is a good debt. It is like the concept of using money to make more money. Let’s look at a few examples:
- Business equipment/tools
- If debt is used to buy business equipment/tool, it is a good debt because the purchase can help you generate income for your business. When you have more income for your business, you can pay off the debt.
- If debt is used to buy investments, it is a good debt because investments can provide income and capital returns to grow your wealth. When your wealth grows, you can pay off the debt.
- If debt is used to pay for education, it is also a good debt because education can help you grow. The more knowledge you have, the more earning potential you can get. When you earn more, you can pay off the debt.
A debt may also be seen as good if it can help you reduce your expenses. For example, loans for investment and business purposes are generally tax deductible.
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Bad debts are debts that cannot offer you any returns and can potentially drain your wealth. Let’s look at a few common examples:
- Cars and motor vehicles
- If debt is used to buy a car, it is generally a bad debt because cars depreciate in value over a short time and you end up paying more than the car’s value. This also applies to other motor vehicles such as bikes and other items that depreciate in value.
- There may be an exception if the car or motor vehicle is able to produce an income or return that is greater than the debt.
- Credit cards and personal loans
- Credit cards and personal loans are usually used to pay for personal needs and wants. Even if they are used on a personal need (e.g. emergency expense), they are still considered to be bad debts because they often come with very high interest costs.
- It is extremely difficult to find a wise purchase that can produce returns greater than the costs of such debts.
- Other luxury/lavish items
If debt is used to buy branded bags, accessories, clothing, toys or other luxury/lavish items that you want to have but do not need, then the debt is clearly a bad one.
Most luxury/lavish items depreciate in value over time. When you decide to buy these, you are satisfying your temporary desire at the expense of your wealth. By the time you realise that your wealth is more important, you will most likely regret the purchase.
In addition, bad debts are generally not tax deductible.
Next time when you get a debt, make sure you use it wisely. Make it a good debt!