In today’s lifestyle it is not completely possible to live debt-free life. Every person has some or the other form of debt either in the form of long term debt, short term debt or a credit card debt.
There are very few people who earn enough and have a surplus after paying for important purchases such as home or car or education. When you are buying on credit there is a very important factor to consider whether debt incurred is a good debt or a bad debt.
Let us now understand the difference between good debt and bad debt.
Good Debt
Good debt is like an investment that grows in terms of value and has a long term benefit in terms of income. Good debt is very secured debt and it has very low-interest rates.
Student loan
The best example of good debt is student loans which are paid in the college for education. Let us understand how a student loan is good debt.
A college education increases the value and potential of the student. After completion of the course, the employer hires these job aspirants for the increased potential. The student loan is good debt as it increases the knowledge of the students and makes them capable to get the job. Student loans have a low-interest rate when compared to other types of debts. A student loan that is spent on obtaining a professional degree can get you a job.
Related- Pay for your Education without getting into too much debt
Home loan
Buying a home through a loan is a good debt. Similar to student loans, even mortgages on home have less interest rate. But here the mortgage loans are generally long term for 15 years to 30 years or more. The advantage is home loans or mortgages loans have low-interest rates. A borrower who has taken a mortgage loan indirectly contributes into investments. After the home loan is completely paid off the title of the owner is transferred to the borrower and it becomes an investment asset. The market value of home increases over a period of time.
Good debts are very important as they contribute to long term investment. Here is another example of good debt.
Auto loan
Auto loans are good debts if the borrower is into business. The vehicles from auto loans will make an effective contribution to the business. Once the loan is paid off the borrower gets the clear title from the lender. The assets title gets transferred to the borrower from the lender. In auto loans assets such as Cars, buses, trucks, motorcycles, motor vehicles and other equipment are covered.
The market value of the auto loans does not increase because technology changes and assets will reduce its market value. The asset value reduces because of wear and tear and depreciation. Auto loans asset value depreciates, so it is advisable that paying more initial deposit money and acquiring the asset will be beneficial. If you extend loan tenure you will pay high interest monthly payments. Shorter the loan tenure the more beneficial to the borrower.
Bad Debt
A debt which does not give you long term benefits or the debts which lose their value in a quick span of time are called bad debt. Bad debt has a high-interest rate.
Credit card Debt
The best example of bad debt is a credit card. Always remember the rule for bad debt. If you cannot afford to pay for it, you do not need it hence do not purchase it. Suppose you purchased a pair of shoes using your credit card for some reason you could not afford to pay the balance on your credit card for years, the price of the shoes would fall down and they would be outdated and out of fashion. The purchase you made has no long term benefit.
Click here to know Cash Withdrawal using Credit Card
Cash loans
Cash loans or payday loans are a bad kind of debts. In Payday loans the borrower issues a personal check to the lender for a certain amount including the fee charges. Until the next payday borrower has time to pay back the loan amount. The borrower is liable to pay the interest rate and the fee charges. If a borrower is unable to pay on the payday it will roll back on to the next payday with additional interest rate and another processing fee.
Payday loans are dangerous emergency cash loans. Based on the level of your emergency you can choose this loan. Experts say that payday loans are the last option that borrowers should consider because they are very expensive than any other loans. Hence payday loans are considered as bad debts because of their expensive nature.
Title loan
A title loan is another type of loan which is considered as bad debt where loan amount is issued considering the titled assets. Assets that you own are put as collateral and a loan is issued. This is another type of emergency cash loan. This is considered as bad debt because if you cannot pay the loan the collateral assets are seized.
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Conclusion
Good debts or bad debts both come to rescue in times of emergencies. Most of the time good debts are having low-interest rates. Bad debts are risky and have high-interest rates. Consider carefully your income earning capability and your previous debts and choose your debt either good debt or bad debt. If you missed your payments or if you go default on the loan or any debt you will lose your collateral and goodwill. Sometimes legal actions may also be taken on you for defaults.
About the author
Vinay Kumar Goguru is a finance professional with more than 8 years of diverse experience as a researcher, instructor and Industry work experience with both public and private entities. Prior to MyMoneySouq, he spent 6 years in Berkadia, It's a commercial mortgage banking company. He has a "Doctoral Degree in Commerce" and two master's degrees with a specialization in Finance, one as Master of Commerce and other as Master of Business Administration. He has written several articles on personal finance, published by different International journals. He loves traveling, reading and writing is his passion. He has a dream of writing a book on his favorite finance topics.
