Good Debt vs Bad Debt – All You Need To Know

Sometimes, it becomes unavoidable to have some level of debt and a need to borrow money as debt from the market. As we know that debt often acts as a liability for us, so it becomes crucial to settle down it as soon as possible to mitigate the burden of heavy interest charges and to prevent a situation of insolvency. Having proper knowledge and awareness of the good and bad types of debt can help ensure your debt doesn’t become overwhelming.

Before we deep dive into learning the types of debt, firstly let’s learn, 

What is Debt?

Debt has several meanings sometimes it is called loan, borrowing, or liability which can either be short-term or long-term. We can distinguish debt into three major types.

Personal Debt: A personal loan is a type of borrowing in which a person borrows from any institution or organization which a motive to satisfy his personal needs and wants. Some of the personal loans are categorized as Consumer Durable Personal Loan, Education Loan, Deferred loans for different purposes like marriage, trip to enjoy, Repair and fixing home, medical emergency, loan to settle down other borrowings, etc.

Mortgage Debt: Mortgage loans are those loans that mandate surety for their approval. These are generally taken relatively to cover the class of properties such as Loans against property, Home loans, Agriculture loans, car or bike loans, etc.

Business Debt: Every business needs money for its survival, so in that case, sometimes people take business loans to run a business or any particular purpose related to a business. These are Term loans, Cash-Credit facilities, Letters of Credit (LC), Bank Guarantees, or other Business Loans.

These are the general types of debts which include large varieties of loans. Due to these diversities of loans, it often evolves challenges to categorize which one is a bad loan and which one is a good loan and put a big question sometimes in front of us,

How to Distinguish Between Good Debts and Bad Debts?

“Debt can be a good thing and it can be a bad thing, it all depends in terms of how you use it.”

The purpose of taking and how you use any particular loan tells you about its category. If its use helps in making money for you, then it will be considered Good Debt, and if it takes money from you then it will be a Bad Debt for you.

‘Good Debt Makes Money for You,
Bad Debt Takes Money from You.’

Bad Debt is paid by your other income or salary and good debt is paid by the income generated by that particular debt itself. Good debt is considered to be an investment by you, bad debt is not.

Good Debts lead to an increase in value and Bad debts lead to a decrease in value.

Let’s take an example to express it clearly,

Suppose you buy a car for your own purposes on EMI and use it in your daily life with costs including EMI amount, Fuel, Maintenance, Insurance cover, Parking fees (occasionally), and tax. So as you used it more and more its market value depreciates and you are spending the cost as well and your expenditures are undoubtedly increasing, which can cause a situation of insolvency in the future and eventually it will generate a negative cash flow for you then it will overall come in a category of Bad Debts.

Now, on the other hand, if the same car is purchased on EMI and will be used to generate rental income by giving it on lease to UBER, OLA, or any other party then it will help you earn a decent or even a small amount after excluding other costs will generate a positive cash flow for you. That will be regarded as good debt for you.

It seems that as we have discussed their nature and applicability and we have all the way got a brief exposure of how we can assume the variety of debts but to increase the credibility and legitimacy about your glaring choice, here are the most important three simple and golden rules which will shed off all your confusion related to debts that which belongs to which category.

3 Simple and Golden Rules to Differentiate the Debts:

• Good Debts always creates a positive cash flow bad debts always create a negative cash flow
• Good Debts can be settled by themselves with no other source of income needed to reimburse them and Bad debts are often settled by salary/other income
• Good Debts help you to make money from the borrowed amount, bad debts are uncertain and in most cases bring insolvency or bankruptcy from the borrowed amount.

Hence with the help above rules, we can easily conclude that debt acts as a double-edged sword with two aspects, at one point it can make you rich by increasing your positive cash flow (Good Debts) and at another point, it can absorb all your wealth to make you poorer by increasing your negative cash flow (Bad Debts) and mire you into a “Debt Trap”.