The word ‘debt’ often has a negative connotation, with most individuals associating it with financial distress and the burden of repayments. However, while not managing debt carefully can cause inconveniences, debt in itself is not entirely a bad concept.
When used smartly, debt can be a powerful tool to achieve your goals without waiting months or years to accumulate enough savings. But the difference between good and bad debt comes down to how you use the money and how you plan repayments.
In this article, we’ll explore good vs. bad debt in detail and look at examples of good debt and bad debt to help you make informed financial decisions and comfortably achieve your goals.
What is Good Debt?
Good debt is the money you borrow to build an asset, create opportunities for future income, or increase your net worth. For example, taking an education loan for a master’s degree can help you develop new skills and explore lucrative career opportunities. Similarly, a home loan can help you create a long-term asset that appreciates in value yearly.
Additionally, good debt can also be debt that helps you navigate emergencies or difficult situations, provided you repay it timely. For example, taking a personal loan to cover medical emergencies.
What is Bad Debt?
A bad debt is borrowing money for things that don’t generate long-term value. For example, taking a loan to buy a luxury bag or accumulating high credit card debt. These debts typically have a higher interest rate, which means you may end up paying more than the product’s actual value in the long term.
However, even a high-interest home loan can be a bad debt for an individual who doesn’t have the capability to repay it comfortably.
Now that we know what good and bad debt is, let’s look at the key differences between them.
Good Debt vs Bad Debt
The purpose and repayment of a debt play a major role in determining if it’s good or bad. Here are some standout differences between good and bad debt that will help you make smart borrowing decisions:
Parameter
Good debt
Bad debt
Meaning
Borrowing money to fund investments or opportunities that will create long-term value.
Borrowing money for discretionary purchases that offer no long-term benefits.
Examples
Education loan, business loan, home loan.
Credit card debt, luxury items.
Interest rates
Typically lower and manageable
High interest rates, causing financial strain
Impact on wealth
Helps build long-term wealth or generate future income opportunities
Drains finances without providing any value or returns
So, how can you determine if a loan qualifies for good or bad debt? A simple way is to use an online calculator. For example, an online personalloancalculator can help you determine your potential EMIs and gauge your repayment capability if you want to secure a personal loan. This will help you prevent bad debts and repay the loan comfortably.
Here are a few examples of Good and Bad Debts-
Good Debts
Education Loan: Taking an education loan to fund your studies is considered as a good debt as it allows you to acquire valuable knowledge and upskill yourself to increase your earning potential.
Business Loan: A Business Loan allows you to start or invest in your existing business to improve your products, services, operations. This in turn increases your earning potential. It provides the necessary capital to invest in your business needs.
Mortgage Loan: A mortgage loans allows you to buy your dream home. The home or property you buy can allow you to potentially benefit from the increasing land rates over time.
Bad Debt
Non-Essential Loan: These are loans that someone may use to purchase a luxurious holiday, unnecessary luxury products or products or services they may not absolutely need. These loans do not offer any long term benefit, no income generation potential.
Payday Loan: These loans provide quick cash but may trap the borrower is a trap of borrowing loans in cycle. This loan can cause extra strain if not repaid on time.
High-interest Credit Card: A credit card may be a good financial tool allowing you to finance your needs if used with discipline. However it is a two-edged sword, Credit Card debts often come with a high interest rate which make them difficult to pay off. In case of failure to pay, one may be trapped in a cycle of high-interest loan cycle.
The bottom line
When used smartly, debt can be a powerful tool for achieving short- and long-term goals without financial strain. However, taking loans for discretionary purchases or with high interest rates can deplete your finances without adding any value.
So, make sure to apply with reputed lenders like Tata Capital for affordable interest rates for personal loans and flexible repayment terms. Visit Tata Capital’s official website to explore online loan options today.
05 December 2024
4 mins read
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