Good Debt and Bad Debt – what’s the difference? Aren’t all debts bad?
To make it simple, a good debt eventually puts money back in your pocket while a bad debt is like a sinkhole pulling you down.
But first things first, why do people get into debt?
For most people, borrowing money from a friend or relative is seen as a last resort. Cash becomes short typically after unexpected events such as sudden illness or death in the family, a fire that destroys a home and other possessions, or even the physical loss of money. To make ends meet, a person in need reaches out to one’s close friend or family member. For these situations, borrowing money and getting into debt is necessary.
Bad Debt. Truth be told, a lot of people get into debt for less than ideal reasons. Driven by uncontrolled purchases of and living beyond one’s means, some people slip deeper and deeper into a quicksand of loans.
But you might say that it is impossible to avoid buying stuff or making purchases as part of daily living. That might be true for essentials or those that you absolutely need to survive such as spending money for food, water, shelter, and to send kids to school.
Bad debt occurs when one spends money that he or she has not yet earned. The best example for this is the abuse of credit cards. It is so easy to swipe away payments for purchases with that credit card and walk out of the mall with hands clasping several shopping bags. Irresponsible spending is using credit cards or loaned cash to buy that latest pair of sneakers when you already have ten pairs of shoes at home. Many realize far too late that a credit card is not cash for spending, but a little piece of plastic that lulls them into debt.
Getting a loan just to satisfy a luxurious food craving or a fashion addiction are also examples of bad debt. Taking expensive vacations using borrowed money is also bad debt. In short, a bad debt is made when a person borrows money to spend on frivolous things. A bad debt is money that is spent on stuff that does not grow in value, but instead depreciates over time.
Some examples of liabilities or purchases that depreciate over time include shoes, clothing, a car (albeit some argue that it is a necessity), a fancy watch, and other items that simply empty your wallet. These items actually give birth to other expenses that could further add to your list of debts. Take out a loan to buy that shiny car you’ve always wanted, only to spend more money on gas, new car registration fees, and other vehicle maintenance expenses.
Good Debt. For sure, not all debt is bad. As previously mentioned, a good debt is one that puts money back in your pocket. One could probably take out a huge loan to buy a car that is later used as private car-for-hire, bringing in extra income.
Another example of good debt is getting a business loan to put up that coffee shop or food stall you’ve always dreamed of. Maybe you’ve had a business idea, a product, or service you want to turn into a full-time venture if only you had the financial capital. A small loan for a cellphone upgrade that you can use to start a loading business is also good debt. With a well-planned business loan with affordable terms of payment, you can pursue that dream and create an income stream that will let you pay off the debt while laying the foundations of financial independence.
In sum, one must know the difference between good and bad debt. A bad debt provides short term pleasure but eventually traps you in a cycle of financial hardship. On the other hand, a good debt is well-planned and necessary that eventually produces positive cash flow making your life better in the long run.
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