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How to Recognize the Good Debt & Bad Debt That’s Right for You

“Good debt is a powerful tool, but bad debt can kill you.”

— Robert T. Kiyosaki

A debt is a loan or borrowing of money from an institution or from an individual which you need to repay in a prescribed time, with interest. Before you brand the term Debt as negative, let me tell you, there are two types of it: Good debt and Bad debt.

What is a Good Debt?

Good Debts are those debts used to create wealth or assets which are of long-term utility or an investment from which you gain returns in the future. Good debts are the result of good financial planning and don’t happen all of a sudden.

For example, Housing Loan taken for the first house, Education Loan leading you to a degree that can help to get a Job, Business Loan taken and invested in setting up or expanding a business with a realistic Project Report.

What is a Bad Debt?

A bad debt is borrowing that is used on spending off or that doesn’t create a value or asset. It can be to acquire something of which the value diminishes very soon or one that costs you a lot in terms of interest. It may make you happy temporarily but in a long run can give you nightmares.

E.g., Buying luxury goods with a loan on impulse, spending lavishly on a party or function only for showing off, having a vacation without any financial goals, accumulating Credit Card dues, etc.

A good debt can help you with the following:

1.   Build a good credit history

2.   They are good investments for the future

3.   They help you to either save money or earn money from the assets you created.

At the same time, bad debt can affect your life in this way:

1.   It can put you in a trap or a debt cycle that you cannot repay in a lifetime.

2.   It can cause stress, and anxiety that cause mental and physical health issues.

3.   It keeps you away from achieving your financial goals.

4.   It costs you more and steals from your savings and investments which you may regret later.

How can you know if the Debt you are going to take is Good or Bad?

Just answer the following questions:

1.   Have I analyzed the long-term effect of this loan on my financial life? (If no, stop and reconsider)

2.   What is the return I am going to get after availing of the debt? (If you are unsure of the returns or you know that there are no returns take it as a warning signal)

3.   What is the exact purpose of the debt? Is that an essential need, requirement, or just a fancy add-on? (Remember dealing with money requires more wisdom than emotions, so keep a tab on your impulsions)

While having the Right Debts help you a lot in your financial well-being, restraining bad debts is also a very important achievement. If you are already in a Bad-debt, seek professional help to come out of it as early as possible.

She Writer Sandhya Naren, MBA, CAIIB is a Branch Manager of a Public Sector Bank, and also a Writer, Storyteller, and Women-Coach in Personal Finance. She’s the Co-founder of Manasa Learning Solutions, Life Skills Training Academy for women and children.