What are the differences Between Good Debt And Bad Debt?

To most Singaporeans, all debt is bad. It's money your debt, and that's never something we look forward to. The truth is, things are a little more complicated. There is, after all, grounds why people take loans for his or her houses even if they can pay afford to pay everything in full. It's because not every debts are equal – some are good debts, plus some can be harmful debts. Here's how you can tell the difference between good debt and bad debt.
What Is nice Debt?
A debts are often understood to be good when it's a highly effective utilization of leverage. Without overcomplicating things, consider this example:
Say you borrow S$2 million to purchase a house, that is valued at S$2.4 million (you cannot borrow 100% of the value). With a 30-year loan tenure, at an interest rate of around 1.7 to at least one.9%, repayments will be around $7,500 per month.
To many people, this might be too much of huge financial burden to take on.
To a knowledgeable property investor, this can be good investment opportunity. A reliable landlord might take this type of loan because he or she realises that the property can generate at least S$9,000 in rental income each month.
In effect, the landlord would be making S$1,500 each month in the house, despite covering the loan repayments.
After 3 decades, the landlord sells the house for S$3.5 million, because its value has appreciated. The main difference between your exchanging price yields a profit of around S$1.1 million. In addition, 3 decades of rental income (assuming no vacancies) would have yielded S$540,000.
This may be the thinking behind “good debt”. It is a type of debt that will pay for itself.
Examples Of Good Debt
Generally, a great debt is an investment with returns that exceed your debt and its repayments. In the above example, an investment is property. In other cases, an investment might be assets such as bonds and stocks, or gold.
Here are a few other examples of good debt.
Education Loans: While a university degree may be costly, it can provide career opportunities that will repay the training loan many times over. For example, many people accept our prime costs of a law degree, because a lawyer's income over just 3 to 5 years should be more than enough to settle it.
Business And Investment Loans: Businesses often need capital to begin up, in order to expand. When the clients are able to scale and thereby increase revenue and profit, it will likely be in a position to repay the cost of the borrowed funds, with interest, often over. Individuals can also take unsecured loans for investments, and it'll be considered good debt if the investment can generate more returns than the cost of the loan.
It should be stressed that no above outcomes are guaranteed. A company that can take financing, and then does not make money, might have raised its financial burdens. Instruction loan sometimes doesn't pay off in the immediate term (for instance, an oversupply of graduates within the workforce may make it tough to locate a job).
As for investments, almost always there is an element of risk. Houses do fall in value, as do stocks, bonds, and commodities like gold. Based on definitions, debts incurred to acquire assets that have the potential to create returns is considered good debt.
What Is Bad Debt?
Bad debts are a sunk cost that offers little if any possibility of generating returns. Money used to repay money owed is just lost.
An example of this is incurring credit card debt to buy a brand new gaming console. As an digital camera, there's no chance you will be able to resell it at a profit. Nor will the console directly generate income – unless, obviously, you use it to coach and become a successful professional e-gamer. Actually, it may cost you more income because you also buy games for this.
Note that some bad debt may be unavoidable in everyday life. You may want to borrow it medical reasons, or if you face litigation. The bottom line is to ensure that you incur bad debts only under these necessary circumstances.
Avoid incurring bad debt for luxury items, for example taking loans to buy a luxury handbag or a car you know you can't usually afford. In both cases, they offer little possibility of generating any positive return.
If you have no choice but to acquire bad debt, avoid using a money advance from credit cards. The interest rate is excessive at 25.9% per year, and you usually have to pay for a money advance fee.
Instead, find a personal loan having a lower interest rate (about 6% per year) and a manageable instalment plan. This can encourage you to pay back the borrowed funds promptly so your debt doesn't snowball.
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