What is debt?
Debt is anything owed by one person to another. In business, you might require more funds than what you have at hand, forcing you to go into debt. Here are four types of debt :
- Secured debt– is a debt based on collateral. You need an asset to secure the loan e.g land
- Unsecured debt – this type of debt requires no collateral as security e.g credit cards
- Revolving debt – this type of debt is pegged on a certain amount of money you can borrow from. e.g credit card debts.
- Mortgages– this type of debt helps you make real estate purchases e.g a home or apartment.
Debt can further be subdivided into two categories, good and bad.
Good debt
This is money owed for things that can help build or increase your income over time.
The guidelines of good debt are simple yet complex. A lot goes into determining the risk and outcome of money borrowed. The primary question is will the debt pay back more than what you’ve put in?
Understanding the difference between good and bad debt is crucial to make informed decisions on if, when, and how much to borrow. Good debt will ideally be in low amounts and help you achieve your financial goals.
Some examples of good debt include:
- Mortgages – Taking up a mortgage not only provides a roof over your head but it also offers a lifetime asset.
- Student loans – Taking a loan to invest in your future makes this a good debt with low-interest rates that can be payable upon employment.
- Business loan – Depending on the success of your business, this is considered good as it increases your overall income.
Bad debt
This is money taken away from your net worth. This is money used to pay for things that lose value and don’t contribute to your income. Bad debt can also be money that remains unpaid long after offering products or services.
Common bad debts are such as:
- Credit cards- Credit cards are considered both good and bad debt. These cards come in handy when finances are tight, they have steep interest rates, and with poor discipline, you could find yourself deep in debt.
- Car finance- When purchasing a vehicle, it’s always best to pay as much as you can upfront. This lowers your interest rates as cars depreciate in value.
- Personal loans – A personal loan can either be good or bad debt, depending on what you use it for. This type of loan has a short repayment period making the interest rate high.
- Payday loans – This type of loan should be your last result. Its kind is usually unsecured, short-term, and combined with multiple services and late fees, could quickly run you deep in debt.
With the current times, making meaningful debt options could save your future!
Sources: Credit, Schwab Money Wise, cnbc
