Good Debt vs Bad Debt

Debt. This word strikes fear in a lot of people’s mind. Debt is a very cliché word and has suffered a negative stereotyping and connotation in the public domain. In reality, debt just needs to be learnt and understood properly to discover that it is not as scary as people think.

According to Investopedia, Debt is:

• Money borrowed by one party from another.

• Many corporations and individuals use debt as a method of making large purchases that they could not afford under normal circumstances.

• In a debt-based financial arrangement, the borrowing party gets permission to borrow money under the condition that it must be paid back at a later date, usually with interest.

Debt is entangled to Interest repayment with Principal. Debt is often referred to as the borrower’s last resort of repayment to the lender. A lot of people are hesitant to commit to debt because they think it will strangle their budget and lead them to financial disaster one day. This statement might be true but NOT entirely true. This financial doom might happen only if you use Bad Debt over Good Debt.

Firstly, let’s observe the definition of both debts.

Bad Debt

Bad debt is a contingency that must be accounted for by all businesses who extend credit to customers, as there is always a risk that the payment will not be received. In short, bad debt is money owed to a creditor that has enforcement for a borrower to repay Interest attached to Principal for the term allowed by the lender.

Bad debt also is a debt that cannot be repaid by the borrower which in this instance, they are responsible for servicing the repayments by using their hard-earned income. Bad Debt is also referred to as the purchase of depreciating assets or products or services that have no lasting value in the long term.

All financial commitments that do NOT add a net value in short/long term can be classified as bad debts. Examples of bad debts include credit card purchases, private car loans, personal loans, holiday/travel loans, etc. Therefore, before committing to any sort of depreciating assets, it is highly recommended to consult first with the right people in the industry with a high degree of expertise, real-life experience and proven track record.

Good Debt

Good Debt is a debt acquired to increase the financial net worth (cash flow or income) in the short/long term.

In short, Good Debt can also be described as a purchase of appreciating assets.

There have been many arguments on how to decide which one is Good Debt or Bad Debt. It depends on the level of financial literacy, depth of understanding debt and the way the borrowers use their debt for. A house can be classified as a Good Debt for many people, but it is usually a Bad Debt from cashflow point of view. With the fact that your dwelling demands constant cash outflow, it is quite obvious that our own home is a Bad Debt sample.

Another example is a student loan. Many people refer to student loans as Good Debt because it is an investment for their future career. But student loan can also be classified as Bad Debt as student qualification alone does not guarantee any future income. We found many people with bachelor degrees or master degrees who work in different role from their own qualifications. Other examples of Good Debt include a loan for property investments, small business loans, etc.

The main point of our real estate belief is encouraging people’s awareness to increase Good Debt significantly in comparison to their Bad Debt. In short, Good Debt needs to be higher than Bad Debt. This is where financial freedom achieved.

Valid and up-to-date information plays an important role in gaining a comprehensive understanding of Good Debt and Bad Debt. Our commitment as a trusted partner is to keep ourselves and our customers well educated in this fast-ever-changing world and to ensure that a safety net/plan for our customers is provided before committing to any debts that might put them further away from their financial goals.

If you have any doubt in structuring your debts in any form, please reach out to our office via email at info@cvig.com.au or phone (02) 8386 2977 and we will direct you to the right contact specifically tailored with your financial goals.