Understanding Good and Bad Debts
Who enjoys thinking that you have a debt to pay? I would rather enjoy my salary in full than allocate some of it to pay off debts. But this can’t be so because everybody, sooner or later, will owe someone something and, yes, you have to pay for it. Debts usually fall into the category of liability. But before I tell you how to avoid owing debts, you must first understand that there are two kinds of debts, the good debt and the bad debt. Though both means that you have to pay whoever you owed something to, there is still a big difference between the two.
Bad debts are those debts that depreciate over time or lose its value. I usually call bad debts as anything that I acquired because I want to have it not because I need it. I categorize car loans under bad debts because as soon as you signed the paperwork involved in buying a car, its value depreciates even before the ink dries on the paper. You can never resell your car at the same price you bought it first. The value of your newly-bought car reduces with time. It is much wiser to purchase a secondhand car and maintain it for two years. It is much cheaper plus, with good maintenance, you can have it as long as a brand new one.
I also think credit cards are bad debts unless used with restraint. Just because it seems like you always have the money to buy things by using your credit card, it does not mean that you are not going to pay for it, because you do. And the interest rate is high. What if what you bought is all because of your wants not needs and you did not exercise enough control in using it? What then?
Good debts, for me, are those debts that increase in value over time and do not lose its value. Unlike bad debts, I call good debts as those that I acquired because I need it not because I want it. Do you see the difference? A student loan is one great example of a good debt. Yes, you owed a lot of money because of the student loan, but after you graduate and land a good job, is it not considered a good debt if the outcome gave you a good education, thus, allowing you to have a higher-paying job?
Another good example of a good debt is mortgages and business loans. Though some would disagree with my opinion, I think that anything that has a value that increases over time is a good debt. If your business picked up or became a success, would it not mean a good debt?
Do not forget though that a good debt can become a bad debt anytime if your expenses are much higher than your income. Once you constantly miss a payment because of your living-above-your-means lifestyle, it could go down from there. To asses for this, list down your income, expenses and debts. If the ratio between debt and income showed up higher than 36% (it should be between 28% and 36%) limit your expenses and cut back on some of them to somehow pay your debts and decrease its interest rate.
To avoid bad debts, know your limits. Having a credit card does not mean that you have to exhaust its limit every time. It is understood that having one requires you to be responsible. Do use your credit cards wisely. When you notice that you are spending way too much on unnecessary things, stop before the interest on your debts grows to a much bigger proportion that you cannot afford to pay.
Article by Nakagava Ltd., creator of PiggyBob™, the first truly user friendly personal finance and appointment scheduling software. PiggyBob™ is an extremely convenient tool to help you keep track of your income and expenses, plus a very useful printable calendar to record all important events in your life.
