Debt being split into good debt or bad debt is an argument that has been on for years.
While some people believe that debt can be good if it is being used for things that save you time and money, contribute to your personal growth, or finance essential services, others believe that all forms of debt are bad.
It is hard to say any debt is good debt but for sure there is bad debt. A general guideline is, if it increases your net worth or has future value, it’s okay; if it doesn’t do that or you don’t have a certain way to pay back, it is for sure bad debt.
The reality is without debt, some people can’t further their education, start their businesses or eat on certain days. While debt should be avoided if possible, it can be viewed as an investment when it is being channeled into things that could improve your finances or let you live at all.
Debt can be okay if it is used for expanding a business, paying for essential needs, and increasing your financial value. It shouldn’t be taken at all when it involves luxury, no matter how bad one might think they need it.
Debt should never be taken to participate in activities or buy items to impress others. Incurring debt for anything that decreases in value once you buy it should be considered bad.
Sometimes debts are bad not because of the purpose but because of the terms.
How to know if the debt is bad for you
Income Ratio
A good way to check if you should take up a debt is to compare your debt to income ratio. If your income cannot cover your needs with enough left to pay your debts, then that is a clue that it isn’t for you. Any debt that places you on over a 43% debt to income ratio should be considered bad debt.
Interest rate & Repayment terms
If the interest rate is too high or compounding, best to avoid it. You should also check with early repayment terms and late repayment terms. Take into consideration the repayment period.
This should be considered together with the interest rate. Often a longer period of repayment means a higher interest rate. If the interest rate is inconvenient it can also mean a longer repayment period, leading to a higher interest.
Installment amount and intervals
Oftentimes people also tend to not consider the installment amount and intervals. This should also be looked into. Who your lender is also matters a lot. Do they have a predatory history? If yes, desist. The simplicity and transparency of the process should also be considered. Lastly, the disbursement time for the loan should also be taken into consideration.
Can debt be a bad thing? Definitely! Is there such a thing as good debt? It is hard to say.