Good Debt Vs. Bad Debt
When growing up we were always told to stay away from debt. However debts is not the problem, the problem is what type of debt you get yourself into. There is good debt and bad debt. Let’s take a closer look.
Have you ever thought how debt is created ? Let’s take this example: we are leaving under the pandemic where governments have ordered everyone to stay home, employees are on furlough and businesses have had to shutdown. Now how can the government afford to support businesses and pay salaries when the economy is stagnant ? What they are actually doing is, they are printing more money. Not real money but virtual money. Let’s say they have 1 million in their bank account and they round this up to 10 billion or any other amount they need.
Now how is this done? Based on what? This starts at the treasury level, the treasury will then have a bond or some other financial instrument. Let’s say it’s a bond to the central bank. So the central bank lends to the big banks, which in turn lend to the rich, now by rich, we mean anyone that can get into debt. This is done by buying assets, such as companies and real estate. It will then go from the borrowers (aka. the rich) and flow into the economy and gets things going. The debt will then be paid back through taxes.
The above process of injecting money into the economy is called Quantitative Easing.
We are all familiar with the old adage “it takes money to make money”. This right there explains what good debt is. If the debt you take on helps generate cash flow and increase your net worth, that is considered a positive. There are a few notable things worth going into debt.
Small Business Ownership- One of the main reasons to start your own business is being your own boss. Not only you avoid relying on a third party company hiring you and giving you a paycheck, but your future earnings will only make you work harder. Like any small business there is always the risk of failure, but your chances of success are great if you work in a field you are passionate and knowledgeable about.
Real Estate- There are several ways to make money in real estate. One of them is purchasing a house, living in it for as many years and then selling at a profit. Another way of going about this, again purchasing a house and then renting out. This way you will be sure to receive a monthly income.
While on one hand we have good debt that can potentially increase a person’s net worth, bad debt is when you borrow money to purchase items that will depreciate with time. Bad debt is also debt that carries high interest rates, like credit card debt. The general rule to avoid bad debt is: if you can’t afford it and don’t need it, don’t buy it. Bad debt include:
Credit Cards- One of the worst forms of bad debt. Interest rates are typically higher than other consumer loans.
Consumable goods and services- groceries, vacations, fuel, and so on are all items commonly bought with borrowed money (i.e. credit card). Just think about all the money paid in interest that could have been spared and spent more wisely.
Cars- Cars, specially new cars are very expensive. While cars are useful and needed in our everyday life for errands and getting around, the interest rates paid on them are a waste. Let’s put it this way, by the time you leave the parking lot your car has already decreased in value.
The question you should ask yourself when borrowing money, be it for a car, a mortgage, for a new business and even for a student loan; Will this debt pay back more than what I put in? Seems like a simple questions although it is a questions that requires a lot of thought. How and when will the repayment take place? What about interest fees ? Will a debt still make sense after having asked yourself these questions?
The key is what the debt does for you — and it should always be more than what you do for the debt.
It all brings us back to your financial literacy and financial intelligence. It is important to know how to operate with debt.