What’s the Difference Between Good Debt and Bad Debt?
Debt for most of us is simply something that is part of us—it is a part of life. It is the way we manage our bills and pay for large ticket items like homes and cars. However, Singaporeans have bad blood for debt. To them, all debt is bad debt. It is money you owe that you are required to pay back, something you don’t look forward to.
There is a reality that everyone must agree to, that it is almost impossible to live entirely without debt unless of course, you earn millions of money every day. We rely on loans to live comfortably in our own homes and drive our own cars. However, the most crucial consideration to take when getting credit is whether the debt is good debt or bad debt. It is because debts are not all the same. Here is how to tell them apart.
What is good debt
Good debt is an investment that will increase value wise and generate a long-term or short-term income. For instance, applying for a student loan to pay for a college fees is an example of a good debt. To know why; think of it this way, student loans typically have interest rates that are lower than other types of debt. Secondly, university education empowers and raises your value as an employee and increasesthe potential of earning good income in future.
Examples of good debts
Both short-term and long-term investments provide an opportunity to create income, and a long-term investment can be the best chance for most people have to create wealth. From bonds to properties and stocks, it is nearly impossible to go wrong with investments
Aside from investing, there are many other ways one can make money. On the brighter side, the most straightforward strategy is buying a house, live in it and sell it later at a higher price. Residential real estate can also be used to generate income by renting out the residence or taking in a boarder.
Small business ownership
The aim of small businesses is to make money. Earning income is a fundamental benefit of entrepreneurship while also becoming your own boss is a bonus result. Not only are you available to work as an employee and receive a paycheck every month, but you also get the opportunity to work hard and earn more from the business.
From the example, we mentioned that knowledge is a long-term indirect investment. The more knowledgeable one becomes, the greater the individual becomes. Education holds a positive correlation with the prospect to finding employment. Learned workers are likely to land in good jobs that are well-paying, and the individual is expected to repay the loan within a few years upon entering the workforce as student loans have relatively low-interest rates.
While good debt may seem all great idea, it is quite essential to note that it is not guaranteed that everything will run as planned. Some ideas don’t work out as intended. Another look at the above presumed good debts can signal that it is not always that smooth.
For instance, who told you that education is a guaranteed ticket to success and wealth? There are so many people across the world who studied and graduated but never got jobs. Specific considerations must be made, like selecting a good and favorable course, you must be willing to accept low pay or relocation, and lastly, you may require to gather all the patience in the world as you wait for that job to come your way.
Additionally, not all businesses succeed in Singapore. If little or no effort is put, a company is more likely to collapse faster than it was established. However, proper planning, hard work, and persistence will grow the business.
Investing is quite complex. If you are not a fanatic, it is better to keep off. Whether you are investing in property, stocks or bonds, investing is putting your money into risk.
What is bad debt
Bad debt is a sunk cost that provides little chance of generating returns. In other words, the returns are never guaranteed. While good debt can have a downside, meaning that the debtor took the debt in good faith hoping that it will yield returns, bad debt is just bad. Everything purchased using debts that depreciate instead of appreciating in value is downright bad debt.
Examples of bad debt
Cars are quite expensive, but they are a valuable asset for us as they take us to wherever we want to go, whenever we feel like. New cars are expensive, and it is logic that not every Singaporean can afford them. However, buying a car with interest or credit is simply a waste of money. You can never recover even if you sell the car after a month of use. Cars primarily the new ones, tend to depreciate quickly and even if you wanted to buy and sell later, it would be at a loss, unlike properties and lands which appreciate every single day.
Consumables, clothes, and service
Just like cars, a million-dollar dress is no longer worth the million the first day you put it on. Clothes lose value quickly, and it is the same reason why you can never sell clothes at the same price you bought it. In fact, half or less the amount is the expected rate. Additionally, foods, vacations, and services like making your hair or servicing our car are bad debt because you will not recover from the debt. Any interest paid on those items is money lost.
We have already established that we cannot do without debt. However, the decisions that you make regarding these debts greatly determines whether they’re good debts and bad debts on your side. For instance, if you bought a car for commercial purposes.
The bottom-line is that it will still depreciate but will have made vast lump sums of money for you, which you can use to offset the accrued interest. That is a bad debt made right. Good debts can also have downsides; it is only wise that you plan and think through the type of debt you want to borrow and determine whether it is worth it or not.