good debt vs bad debt

When Being In Debt Is A Good Thing


Engaging in the right type of debt can be rewarding in the future.

There are times when being in debt is unavoidable. You may have needed to take up a loan to pay for your child’s tuition or settle hospital bills when a family member falls ill.

While it is ideal practice to be as debt-free as possible, there are certain instances when taking on debt can be a smart financial move. This sounds crazy, and you might be quick to reason that playing hide-and-seek with your creditor is never fun — true that. But being in debt for the right reasons can make even a bleak future bright.

To make it easy for you, here’s a quick a guide on how to tell if the money you’ve borrowed is good debt or bad debt.

How can debt be good?

Whenever you borrow money to pay for something which will make you more money in the future, that is good debt. You borrow money primarily to acquire things of value, for example buying properties or items which can help you make money.

Good debt done right can be looked at as a type of investment which can generate income in the long term.

Here are some examples of good debt:

✓For buying your home
Buying properties is considered good investment because these assets usually appreciate over time. Prices can potentially double in a span of ten years. By selling your property at the right time, you may earn triple the amount you initially paid.

✓For buying or improving an investment property
Be it for residential or commercial, borrowing money to buy or improve an investment property can be a good debt.

If managed properly, what you earn from renting out the property can be enough to cover your monthly payments. You could be maxing out your profits in a matter of years. In this case, think long-term.

✓For expanding your business
Anyone who owns a business wants their business to grow. One way to do that is by hiring more people, renting out a bigger space, or buying new hardware to offer more services. However, all of these need fresh capital, which can be done by taking out loans.

Even big companies take on good debt. They can opt to raise capital by issuing corporate bonds to the public. More capital means more money to invest and hopefully, if you play your cards right, more profits.

✓For finishing your education
Whether you’re a parent or a student, borrowing to finish school is a good investment. Graduates are the top candidates considered for higher pay. Investing in the right kind of knowledge will definitely take you further in life – and possibly up your income.

✓Refinancing old debt
If you have an old loan with high interest rates, switching to a lower interest rate once it becomes available is considered a good debt and will save you thousands of pesos. If you owe P20,000 with 3.5% interest rate, and you refinance it at a lower interest rate of 2.5%, you can automatically save P200 per monthly repayment.

A word of caution
Just transferring your credit can have costly implications. Make sure you read the terms before applying to refinance your loan.

✓For buying a car, jeepney, or tricycle which will be used for public transport
Imagine not having to pay for boundary. In five years after paying off what you borrowed, you can take home whatever you earned on that day. A jeepney driver can earn an average of P300 to P500 for one way depending on his route.

This means if he is hardworking and earns P3,000 in one day, he takes home P60,000 a month — this is thrice the amount of what a regular BPO agent gets as starter pay.

✓For paying hospital bills
If you or your loved one gets sick and needs extensive medical attention, borrowing money to cover those bills makes it a good debt simply because there is nothing more valuable than life.

The reason you work and earn money is that you and your family are able to live a healthy and comfortable life — and you can’t put a price on that

What makes debt bad?

Even without pointing it out, we are sure you already know when you have bad debt in your hands. We’ve all had a taste of it. Debt with high interest rates can easily blow out of proportion, and burn holes through your pockets.

Any debt that only drains your funds without any prospect of gaining it back in the future nor any clue on how to repay it is bad debt.

Here are some examples of bad debt:

✗Charging expenses to credit cards without keeping track
You can easily accumulate bad debt when you swipe without a care and buy on impulse using your credit card. Credit card interest rates average at 3.5% per month, and the interest is compounded monthly.

You can just imagine the trouble you’ll be in if you hold three cards at one time, each maxed out at P20,000. By the end of the year, you owe the bank P30,666 on interest alone for a total balance of P90,666!

For your information
Credit cards often offer rebates and other rewards to compensate for the high interest. Find the right one for you and compare which offers the best credit card deals.

✗For buying luxury items you don’t really need and afford
Your neighbor just bought a brand new 40-inch TV. You’ve seen how awesome it is and now you want one, too! Hold it — think first if you have the money to pay for it.

Unless you’re buying a painting, gold, diamonds and other precious minerals that retain or gain value over time, television, luxury cars and the like will depreciate and the high interest rates of borrowing will make them lose their value even sooner.

✗For paying bills, rent and other similar financial commitments
Sure, you’ve had to borrow money to make ends meet for this month. Chances are, next month you’ll probably do the same. This means you are living beyond your means. You are not earning enough to support your monthly expenses, and you needed to borrow money to cover the deficit.

Not only is this self-destructive, unless you find some means to generate more income or tighten up the reigns on your cash flow, your debt will only accumulate.

✗Borrowing from ‘5/6’
This is the common choice of lender for most Filipinos because of its accessibility. You don’t need paperworks or approval whenever you need to borrow money. Most 5/6 lenders also offer easy terms of payment.

But in exchange, they charge extremely high interest rates. As the name implies, you pay P6 for P5 borrowed, which is equivalent to 20% interest, or a whopping 791.61% compounding interest per year. So if you borrow P1,000, you would have to pay back P8,916.10 after one year.

Can you turn bad debts into good?

Yes, you can. If you find yourself stuck with bad debt, the first step you can do for yourself is stop borrowing money until you’ve found a way to repay your debt. Look for lower interest rates to refinance your debt and prioritize paying it off.

Seek help from professionals or your creditors if you have to, to work out a debt repayment plan. You can also find inspiration from other people who have succeeded in turning their debt around.

We’ve listed here 5 Reasons You Can’t Get Out of Debt and how to go about it.

Remember that taking on any kind of debt is a huge responsibility. Ask yourself the following questions:

  • Can borrowing this money earn you money in the long run?
  • Is this the best rate available and possible for you?
  • Can you shoulder the cost if the interest rate rises in the future?
  • Can you afford the monthly repayments?
  • Have you understood all the terms and conditions that comes with borrowing this money?
  • Are you aware and prepared for the risks involved if anything goes wrong? For example, if you lose your job while in the middle of paying for the debt, what will you do then?
  • How much should you borrow?

If you answered ‘yes’ and are certain about most of the items listed above, then you are borrowing good debt! Do some research and compare rates and terms so you can find the cheapest and best plan available.

But take caution, having good debt doesn’t automatically mean that it will be easier to pay off than bad debts. Even debts done for good can easily spiral out of control and turn bad.

What you need, even before you borrow money, is to have a definite plan on how to pay off your debt as quickly as you can so your good debt remain good.

Read More: Are You Trapped In Debt? Here’s How To Pay Off What You Owe Faster

This article was first published in April 2016 and has been updated for freshness, accuracy and comprehensiveness.

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