Personal Finance

Good debt vs bad debt

Debt has been a part of every body’s life and personal debt gradient is on the rise because credit hasn’t been easier to receive. In everyday life, most of us would not have enough finances in one go when it comes to paying for our apartments or children’s college education. Hence we borrow in one form or the other to get the expenses meet.

Debt is not a simple concept to comprehend, but in fact is a bit difficult one to get hold of. Ideally, as per financial experts’ statements, a person’s total monthly long term debt payments – which includes credit cards and mortgage – should not exceed 36 percent of his/her gross income for a month. This is the bench mark mortgage bankers take in to consideration while appraising the creditworthiness of a potential borrower.

It is very easy to spend far more than what one could afford. It is interesting and intriguing that a large number of people does exactly this and fail to recognize that they are heading down in an abyss – the deeper you sink, the more difficult will be the chances of a recovery. That is unbridled spending. But to avoid debt is not a smart option either. If properly handled, debt can be money spinning as well. That brings us to the concepts of Good Debts and Bad Debts. Let us see what are the differences between good debts and bad debts?

The secret of acting smart with the money is all about learning to discern between good debt and bad debt. Unfortunately this is something that most people around the world fail to be experts in. Good debt is something that helps improve your financial position or net worth. That is, in simpler terms, a good debt increases cash flow. That is, mortgage debt, for example, is good debt. You are borrowing money from someone, but you’re getting a tax advantage so that you are able to cancel interest on an asset that’s gaining in value over time. Also you can live there.

On the other hand bad debt can occur when you buy something that goes down in value immediately. That is, when the thing that has been brought on credit does not have the potential to increase its value. Purchase of disposable goods or durable items or, as commonly found, the use of higher interest credit cards can lead one into bad debts. Ideally, debt-to-income ratio of a person shouldn’t go above 20 percent. That is – while adding up all of your non-mortgage loans, credit cards and outstanding charges – it should not exceed 20% of the annual income. If it goes beyond the 20% mark, that is bad debt and it doesn’t go down well in his/her credit reports even if payments are made in time.

To conclude, debts can be productive if properly and rationally exploited. It is financially draining to incur bad debts but if you could gain more by investing the borrowed money than the interest associated with the credit, then it is good debt which is useful. Managing one’s debt and hence the finances might need a bit of brain scratching. But it is not that enigmatic for a common man to comprehend. After all it is no rocket technology. It is all about learning to manage your finances!