Utang 101: Good Debt and Bad Debt
When applying for loans, it is important to know about good debt and bad debt. One can help you achieve a higher quality of life and more avenues for income, while the other can sink you and have an unfavorable effect on your financial standing.
What is good debt?
A good debt is taking on a loan to purchase anything that can improve your way of life or net worth (Debt 101, Cagan).
These loans usually come with fair interest rates and repayment schedules which you can meet without draining your budget.
Examples of good debt:
- Educational Loans. Getting a loan to finance your studies is considered good debt as education can be a form of investment. Having better education can help you land better-paying jobs, and upskilling can help you gain new skills and expand your job options.
- Capital or Business Loans. Building a stable business can increase and secure your financial standing as well as give you more flexibility. Borrowing money for a business can be very risky, but with a solid business plan and a budget to spend the money wisely, success can come your way.
- Housing Loan. While it can also be a bit risky, taking out a housing loan can provide you with a permanent place to live and an investment vehicle. Flipping a house after renovation or renting it out can give you solid income and help you pay for the loan.
What, then, is bad debt?
On the other hand, a bad debt is taking on a loan to purchase something that depreciates in value or will have an adverse effect on your income. These usually come with high interest rates and short repayment periods.<
It is also considered bad debt if you don’t have the cash to pay for it.
Examples of bad debt:
- Depreciating Assets. It’s not generally a good idea to take out a loan for quickly depreciating assets like cars, clothes, gadgets, etc. These assets lose half their value the moment you take them out. It’s advised that you pay in cash whenever you buy assets like this.
- Credit card debt. It’s very easy to go overboard with credit cards and end up with debt. Aside from purchasing quickly-depreciating assets, interest rates and other fees can easily pile up, aside from payment schedules that can be hard to meet.
- Predatory loans. Taking out loans from predatory lenders carries the risk of ridiculously high interest rates, excessive charges, a lack of any formal contract, short repayment periods, and unethical debt collection practices. All of these factors can have a negative impact on your credit history and entrap you in a debt cycle.
Keep in mind that some debt does fall in between “good” and “bad”. These debts, as per Investopedia, can have a positive or negative impact depending on a person’s financial situation. These include:
- Borrowing money for investments like stocks
- Borrowing to pay off existing loans
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