When it comes to debt, as with our previous post, not all debt is created equal! There’s good debt, which is debt that enables you to purchase assets that spin off income, buy stocks that accumulate over time, or build a business that ensures long-term wealth. Then there’s bad debt, which the vast majority of the population accumulate, which keeps them broke.
Bad debt is a loan that is taken out just to buy a depreciating asset – such as a car, certain collectors items and those that gain wear over time, lowering their value. Bad debt is also that taken out to buy liabilities, such as new toys that won’t help you be more productive, vanity items or anything that will cost you money month on month to maintain, again such as a car! Finally, the majority of bad debt taken out is that to help people get to their next paycheck, make up for shortfalls in income or too many expenses, or lines of credit that that person taking it out can’t manage.
An offshoot version of bad debt is good debt turned bad! This can often happen when somebody takes out a loan for a good reason, but is bad at managing their finances, and so misses a payment, or defaults on the loan, adversely affecting their future credit. It can also happen when someone takes out a loan for an asset, but hasn’t done market research into the best loan and has an interest rate that damages them in the long run compared to a more competitive loan, so if they start a business, it will take them longer to pay off the debt. Finally, if an asset is bought with the loan, but the person hasn’t done their research into the asset, could blow them up, putting them in a financial hole, for example; day-trading stocks when they haven’t done any research or training into trading, starting a business with no prior knowledge of marketing or sales, or generally mismanaging their asset.
The main questions you need to ask yourself when taking out a loan to prevent it from becoming a bad one are:
Will this debt be buying me an asset, or something that can generate money each month?
Can I manage my current household and personal finances well?
Have I done enough research into the asset I’m buying to run and manage it well?
Is this loan competitive, or can I find a better deal elsewhere?
Have I just gone through a big life-change, such as a move, that can affect my credit rating poorly?
If you follow these questions everytime you think about taking out a debt, you should never find yourself in a bad situation (barring any unforeseen circumstances)!
Hopefully this blog post has helped you, and stay tuned for more in the coming days!