Is there such a thing as good debt? What makes debt good and what makes it bad?
In very rare and exceptional cases, there have been cases where debt has proven to be more beneficial than detrimental. This, however, is hardly the case when it comes to personal finances.
Financial gurus would tell you that good debt is the kind of debt that allows you to derive income or purchase an investment that appreciates in value. Quite the opposite would, therefore, be debt that does not allow you to make any income nor used to purchase an asset that appreciates in value. The latter would be “bad” debt.
Lt’s start with good debt – an example is typically given where a consumer buys a house or gets a loan to buy an investment (this could be listed shares). The reasoning then follows that since a house (or an investment) will appreciate in value and can be sold at a higher price at a later stage, one has taken out good debt.
Though the ability to derive income that may have otherwise not have been derived through the loan is an advantage, one needs to be aware that no form of debt comes free. There is a cost to debt. As such, whatever profits you derive will be diminished by this cost of debt. If you take out a personal loan at 20% interest rate compounded daily, will your profits be sufficient to cover the repayment to your creditors, interest and service fees and still allow you to keep a portion of the profits to yourself after taking into account tax implications and managing your working capital efficiently?
Bed debt – this is debt that does not even have the lure of promising a return. It is an out and out complete loss situation. This type of debt would include your credit card, personal loans, clothing accounts, etc. Once taken out, the money is used to buy consumables that will only last for a short period of time while the debt is repayable with high-interest rates over extended terms.
Therefore, if you are wondering if there is such a thing as “good” debt, the answer is “very rarely can debt actually work out to be good”.