Segregating debts into good and bad debts will help borrowers to have better debt management. Some debts are more favorable than other debts. Some debts may be a good investment and they are definitely good debts. Some debts may ruin the reputation of the borrower and they are bad debts. A debt availed for purchasing of any property which has appreciation value is definitely a good debt. The value appreciated may be more than the debt borrowed. Thus, this kind of good debt will have good credit report and generate profit for the borrower. Debt borrowed for purchase of a house or housing site is a good debt as the value of the house will appreciate year after year. A loan taken for a student’s higher education is a good debt as education will serve for individual and nation building. Any debt which creates unhealthy financial situation and do not have any appreciation in value is a bad debt. Credit card debt is usually a bad debt because the items purchased through credit card are consumed fully and do not have appreciation in value. Credit card purchase is also costly debt as the penalty in case of default in repayment is very high.
Bad debts must be paid off first than good debts. Credit card payments and auto loan repayments must be taken first before paying off mortgage loan or student loan. Whatever may be debt, good or bad, a careful and wise decision has to be taken before availing a debt. A debt is always a danger irrespective whether it is good or bad. Too much debt will affect the financial health of the borrower.
Good debt is an investment on property or assets that are earning income for you at a rate greater than the cost (interest) on the debt. Many corporations use something called the hurdle rate to determine if an investment is worthwhile. The hurdle rate is simply the cost of capital. If the hurdle rate is 15%, then only investments or purchases bringing in more than 15% would be considered “good debt.”. Good debt provides positive returns. Purchasing equipment for business would be a wonderful example of this kind of debt. Most equipment pays for itself with the revenue it produces, so structuring a lease or financing program with manageable monthly payments is a wise usage of good debt. Bad debt does not create an income greater than the interest of the debt. Bad debt also includes debt taken for things can’t afford. They produce no return at all. Bad debt doesn’t help to grow your business. The financial success in business and life will largely be determined by the ability to discern between good and bad debt.
Good debt has the potential to increase in value and bad debt has no potential to increase in value. Investments in stocks or bonds are also form part of good bad. Availing debt will be wise only when it is used for good investment purposes such as house mortgage, purchase of stocks, equipments, student loans etc. Availing debt will be bad when it is used for credit card payments, auto loans etc.
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