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Good Debt vs Bad Debt
Debt. This word has a huge negative connotation attached to it right? But as much as we hate it, it has become a part and parcel of our lives. Every big purchase for a common man with an average salary has become possible only through getting into a debt. Be it a personal loan or a credit card. One very interesting concept that we have come across in recent times is the term, good debt. What is exactly is good debt or bad? What is the difference between a good debt and bad debt? Let’s understand all of this today.
Am I in good debt or bad?
Let’s understand this with a very simple example. Today if I say to you that I just took a loan of 40 lacs to fund my higher education, you would not be surprised. Even though 40 Lacs is a huge amount, the net worth of the education I would receive is much higher. Not to forget that it is that education which will enable me to land a job for life. So it surely is good debt. But what if I tell you that I have a debt of 10 lacs on my credit cards. Even though the amount is 4 times lesser, you would probably tell me it is a bad thing right? This is how you can tell if a debt is a good debt or bad.
If the debt you are getting yourself into today, adds value to your future, it counts as good debt. But if the debt is something that does not necessarily add value, instead it hampers your day to day life. It would definitely be treated as bad debt. Now, this is not always black and white. The definition might vary according to every individual’s personal situation. Let’s understand how.
Example 1:
If you are taking a loan to get a house. It is good debt, right? Afterall, when the house is constructed the value would increase manifold. The investment would be worth the rewards. Hence, it is good debt. But if you find out that the area that you bought the property in, is not in demand by buyers, the investment definitely went in vain. Hence, that makes it a bad debt.
Example 2:
A car loan would be considered as bad debt by a few since the value of the car would depreciate over time. But if it matches the cost that you would have otherwise spent on conveyances, it is good debt. Also if it makes your commute to work shorter leaving you with more time to earn more money, it definitely is a good debt.
What you need to do is to analyze the situation carefully. Consider every aspect. And then decide whether you are getting into a good debt or bad.
See the red flags on time
To understand whether you are in good debt or bad, add up all your monthly debt payments. Now divide this by your monthly gross income. This is your debt-to-income ratio. If this ratio crosses 43%, it is a huge red flag. Not only for you personally but also to potential lenders. Your credit score is affected if this ratio is this huge. Since borrowers with a higher debt-to-income ratio are more likely to have problems making monthly payments. Hence creditors shy away from giving them any credit.
Related article: Reduce Monthly EMIs Using Personal Loan Balance Transfer
If you are already in too much debt due to high-interest loans, a balance transfer might be a good way to get out of it. By availing a lower interest rate and the advantage of paying back in smaller EMIs, you can pay off your debts easily. No matter what you do, just keep in mind to do what’s best for your money. If there is anything you’d like advice on, do share in the comments below!
