Everyone wants to live a debt-free life. Financial problems brought about by having huge debt impacts virtually every aspect of our lives that is why we do everything we can to avoid it. Debt, in its simplest definition, is just borrowed money used for whatever purpose we have in mind. If we look at it this way, debt sounds neither good nor bad. It’s just what it is. And while it is entirely possible to live a life free from the burdens of having a debt, there are times when taking out a loan is the right decision to make.
Purpose is What Makes The Difference
As stated earlier, debt is defined as money borrowed for an intent one has in mind. This intent is what makes the distinction between a debt good and a bad debt.
They say that “it takes money to make money.” Good debt is money taken out and used as an investment to help generate income. A loan that was taken out and used to kick-start a small business is an example of a good debt. All business owners expect to earn and gain profit that would soon pay for the loan. Student loans can also be viewed as an example of a good debt. Every student sees a “return on investment” once they graduate and enter the workforce in their chosen field. Real estate mortgages, when used strategically, can also be a form of good debt. A residential property can be rented out, thus making it self-amortizing, and once the mortgage is paid off, the property owners can finally start earning from it.
Bad debts, on the other hand, are debts that are used to purchase anything that depreciates in value and do not generate any income for the debtor. These are the liabilities that have to be avoided at all cost. Cars may be a necessity but it is expensive. Unless you have the money to pay for a brand new car in cash, it would be better to put a hold on your plans for signing up for a car loan. Cars depreciate in value every year. In the event that the car owner decides to sell his car, it would be for a much lower price than its original value. Consumer loans such as credit card debts and payday loans are probably the worst kinds of debt. These debts are often used to make ends meet, or to sustain the “wants” of a person. Bad debt doesn’t do any good for parties involved: the debtor loses money in paying the interest alone, and may soon be buried in a mountain of debt, assuming the debtor no longer has the capacity to pay for it. Creditors lose money on bad debts that are no longer collectible.
The Backup Plan
Taking out a loan is always a risk. A fresh graduate may not find a lucrative career opportunity right away which may lead to struggles in paying off their student loan. Real estate properties may suffer damages brought about by unforeseen circumstances such as fire or natural calamities and will definitely cause a loss of income. Startup businesses may take a while before it generates the expected income. As for bad debts, these could get worse when a debtor lacks financial management skills and is stuck in the dreaded minimum payment loop.
Good debt and bad debt have one thing in common and that is they are both accruing interest. If the debtor hits a financial snag along the way, unpaid debts, along with its ballooning interest rate can be a problem.
It is essential to have a backup plan in case things don’t work out. Having ample savings to cushion one’s fall during hard times is perhaps one of the best backup plans a debtor may have. Savings should be enough to cover basic necessities and loan payments for at least three to six months. For business owners, emergency funds should be enough to cover operating costs and other expenses. This will give any indebted person time to recover and get back their finances back on track much easier than having no savings or emergency funds to count on.
In the event that a debt becomes too much to handle, an indebted person may consider entering a debt relief program. Debt relief programs, as its name states, offers relief to a person whose debt burden becomes too much to bear. These programs may offer either partial or full relief from one’s debt. Most debt relief companies offer a free consultation to their clients to see which program best fits their current financial situation and capacity to pay. Once enrolled in a program, it is best to commit to the agreed plan to have the debt problem resolved, otherwise, noncompliance to the plan may get a debtor kicked out of the program which may lead to even bigger financial problems.
Money is best handled with wisdom and discipline, especially if that money is borrowed. Keep in mind that even those considered as good debts may turn into bad debts when handled thoughtlessly. Most of all, debts should be paid off as soon as possible. Do not let yourself get stuck in the minimum payment trap and suffer the consequences later on. Good decision-making along with sound financial management skills will make any debt less of a burden and more of a much-needed help to anyone who needs it.