DEBT does not only carry a financial burden - it weighs heavily on your state of mind and thoughts of the money you owe can become all-consuming.
Knowing that there is a difference between good debt and bad debt, however, might lighten the load.
Loosely defined, the difference between the two types of debt is the difference between needs and wants. The focus is on what the borrowed money is spent on. Let’s take a look at both.Good debt
A purchase that will appreciate or show value over time can be seen as good debt. A common example of this would be a home loan, taken out to finance a family home. Property nearly always increases in value, and is a potential source of income or retirement money.
Student loans are also a form of good debt, because the outcome of this type of loan is a career which holds both monetary value and promises of a better future.
That is, it’s a debt that will bring about a return on investment. And a great one at that.
Business owners will incur good debt when they borrow capital for endeavours that aim to generate more business or money. This could be the funding of a new invention or buying new equipment to advance the offerings of the business.
A flashy car for personal use, however, will definitely not fall under this umbrella. Bad debt
Bad debt is money borrowed for items guaranteed to depreciate over time, or for purchases that hold no long-term value.
The biggest ‘bad debt’ culprit is credit card debt and along with it, all the splurges consumers usually swipe for - meals, clothes, holidays and entertainment. The value of these types of purchases expires the minute the experience ends. The only thing that lasts is the debt.
Store cards are also a bad idea when it comes to debt. The interest rate on these tends to be well above the prime rate, so you end up paying a lot more for the item bought than was originally printed on the price tag.
Take a bedroom set, for instance, that’s advertised at R2 999. Let’s say you get charged 21% interest over 30 months – you’ll end up paying nearly R8 000 for it!
Car finance, while it might seem to be a need and not a want, is essentially bad debt as well. Keep in mind that cars do not appreciate in value; they depreciate the minute they’re driven off the showroom floor.
You’ll never get all the money back you spent on a car. The grey zone
As with most areas in life, however, there are some grey areas. Credit card debt that’s managed well isn’t necessarily bad debt.
This would constitute paying off the entire amount owed every month, so that the debt does not multiply. In the same manner, store cards that are taken out with a ‘no interest’ option could also be a form of good debt.
But be it good debt or bad debt, the moment you have too much of it to handle, all your debt qualifies as bad debt. Why? Because it will have a negative effect on your finances and quality of life.
The key to balance is simple - never take on more debt than you can afford, and always keep bad debt to a minimum.
* This guest post was submitted by Karen Engelbrecht of ooba
. Opinions expressed are her own.
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