By Supriya Suri
Loans play a major role in helping us achieve our aspirations and achieve many goals in life. In recent times, consumers increasingly use credit for convenient payments and don’t wait to save and spend. But at the same time, some debts tend to become a liability causing undue stress. So, understanding the difference between good debt and bad debt is important for anyone looking to make informed financial decisions.
What is “good debt”?
Good debt can be used to buy assets that may slowly depreciate or, in some cases, grow over time. Savings, loans and investments can be planned to maintain good financial health and secure a stable and secure future. For example, if one takes out a loan for education, it can be considered profitable because it is bound to give good returns and increase income.
However, huge debts should be avoided as much as possible. A small size durable consumer loan is always preferred for someone new to credit, as in addition to establishing a good credit rating, such a durable consumer loan can help increase the affordability of items. , thus responding to aspirations.
Likewise, borrowing for affordable health insurance is good debt because it can protect against unforeseen future risks. Also, borrowing to invest in a business is considered good debt. There is no doubt that there are risks, but assuming that both liabilities and assets have been factored in, this loan is considered a healthy choice. Good debt should be taken with calculated risk for a guaranteed future / high return and to improve financial planning. Good debt provides leverage and additional earnings, whether through returns on investment or through education.
What is a âbad debtâ?
Bad debt is defined as debt that has a negative impact on the financial well-being of an individual. A loan used to purchase a luxury automobile, for example, will be classified as bad debt if the EMI and total loan amount are disproportionately greater than the consumer’s monthly income and annual income. A high interest rate loan is also called bad debt because it imposes a large interest charge on the borrower. Many people borrow to invest in places where they expect a better rate of return than the interest rate, which may or may not be the right decision.
Borrowing money to purchase services and products for personal use that do not provide long-term growth is considered bad debt. One of the most common types of bad debt is owing money on a credit card. These cards often have high interest rates and can quickly become unmanageable. Therefore, avoid debt with high interest rates in order to achieve short-term financial goals, as spending capacity and interest rates are essential when investing in these products and services.
Choosing the right debt
Debt is relative, situational and specific. Good debt for one can be bad for another, depending on their financial situation. Good debt is essentially one of the best ways to gain financial freedom and achieve long-term goals. Before applying for a loan, check whether the loan will pay off or become a liability. It is important to carefully estimate your current financial health and assess the extent to which current borrowing will provide you with long-term benefits.
The author is Vice President, Customer Experience, Home Credit India