The Debt DynamicsBy: Samanada Tulloch, Portfolio Advisor Posted:
Contrary to popular belief, not all debt is bad debt. We all are familiar with the adage “It takes money to make money.” Leveraging can be beneficial to the borrower. This type of debt is known as good debt.
Debt is considered good when it is used to purchase assets that add to your financial wealth or provide additional income. For example:
- Loans to purchase potential appreciating assets such as real estate, to start or to expand your business and to pursue further education.
- To purchase investment instruments such as stocks and bonds. These types of loans are generally referred to as margin loans.
On the other hand, bad debt is loans utilized to purchase anything that decreases in value the minute it’s purchased. These types of debts generally disguised with perks and glamour accompanied by exorbitant interest rates. These include:
- Credit cards- This is the most notorious bad debt people encounter especially millennials. Improper management of plastic can lead to financial destruction. In other words, credit card generally comes with high-interest rates which are silent killers.
- Motor vehicle loans- The value of a motor vehicle general depreciates the minute you drive it off the lot. It is financially prudent to avoid splurging on luxury vehicle if it’s not being paid for with passive income.
- Payday loan- This is another popular debt taken on by individuals who are generally financially unaware. Payday loans are short-term loans taken to get through a crisis. These loans are processed quickly and unsecured as such the interest rates are significantly higher than the credit card rates.
Not all debts can be easily categorized as good or bad. This is dependent on an individual’s financial position and needs. It is imperative to assess the use of the debt to ensure that the gains to be derived from the debt exceeds the cost of the debt. To individuals who are already exposed to significantly high bad debt, it is recommended that you first stop borrowing and try to refinance your debt or consolidate. Make payments on time and always track your debt position periodically as how you would track your investments.