Good Debt VS Bad Debt With Examples


On January 31st, 2024, our team gathered to discuss plans for the next month. Everyone had their own plans, but a common worry was that about 70% of our salaries would go towards rent, groceries, and bills. During our talk, we noticed something interesting: Raman, our content strategist, took an international trip and spent a lot on his credit card. What caught our attention even more was that he asked a colleague and others for money.

We started wondering why Raman went on the trip without enough money. Was it for fun, or something else? This made us think about using credit wisely. It helps, but without a plan to pay it back, it can lead to problems.

Some people describe debt as ‘good’ and some as ‘bad '. Let's understand this with an example :

What Is Good Debt?

Good debt means borrowing money for important things in life. These investments can give back more money later on, helping you build wealth. But even good debt can become a problem if you don't have a plan to pay it back. Examples of good debt include ;

a) Education Loan : Many of you aspire to pursue higher education abroad to fulfill your dreams and acquire valuable skills. Taking out an education loan to attend a reputable university with a promising return on investment can be a wise decision. This investment not only enhances career prospects but also provides long-term benefits that outweigh the initial cost. But always remember that this debt might turn into bad debt if you haven’t thought about the repayment strategy.

Let's understand this with an example: If you want to pursue an MBA from a reputable private university known for its high return on investment (ROI), but you lack the necessary funds. In this scenario, taking out an education loan to attend your dream college would be a sensible decision. By doing so, you not only stand to benefit from enhanced placement opportunities but also gain the prestige associated with the university's brand name for years to come..

b) Business Loan: As an entrepreneur when the savings in business are exhausted, they often borrow money to fund their startup. While business loans are considered good debt, they come with a lot of risks. These risks can be of the business losing, eventually leading you to a debt trap. It's essential to carefully assess the feasibility of the business venture and ensure a solid repayment strategy to mitigate risks associated with borrowing.

Let’s understand this through an example: You open a business of selling online food, let's call it 'Home Made Food,' and obtain a personal loan of about Rs 20 lakhs to start it. As the business progresses, it gradually expands and yields positive results. The initial investment of Rs 20 lakhs now appears insignificant as the business starts to generate substantial returns.

What Is Bad Debt?

Bad debt refers to financial obligations that could lead you into a debt trap in the future. Also, there can be any bad debt if you don’t make the payments timely or don’t have a repayment plan. There are certain debts that are defined as bad debt by people and they are as follows:

a) Luxury Goods: Purchasing luxury items, such as electronics or designer clothing, on credit can result in unnecessary debt accumulation. While these purchases may provide immediate satisfaction, they do not contribute to long-term financial well-being.

b) Credit Cards: Excessive use of credit cards for non-essential expenses can lead to high-interest debt and financial instability. Building a habit of using credit cards for unnecessary purchases can quickly lead to a cycle of debt.

c) Payday and Title Loans: Short-term loans with high interest rates, such as payday and title loans, are often used to bridge financial gaps between paychecks. However, failure to repay these loans can result in high-interest charges and further financial distress.

In conclusion, whether debt is good or bad depends on your consumption, habits, and ability to plan for repayment. By making informed financial decisions and adopting responsible borrowing practices, you can navigate your financial future more effectively. Nevertheless, it's important to remember that you are never alone in this journey and we at FREED are always there to help you in such situations.

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