Are all The Debts Bad? How to Manage Bad Debt?

Are all the debts dreadful? I don’t think so. What I believe is that some debt can really improve one’s credit score and worthiness as a borrower. Let us first see what are good debts and bad debts

Good Debt:

A debt which appreciates in value in direct proportion to passage of time is a Good Debt. Simply speaking a debt, that produce or increase cash flow is a good debt. For example, home Loans or Mortgage Loans are very good debt, because one gets tax advantage, along with the time price of that property increases, helping you to write off interest as an asset and along with all this you get to live there.

A loan to start a business can also be considered as a good debt, if you can really get good returns from the business. But, here the returns should be such that in due course of time one earns more than the amount one takes to start the business.

The thumb rule is – buying some property, taking loan to get rid of some high interest loans, investing in some high yield stocks, bonds and other instruments.

Bad Debt

Bad Debt are those debts which makes a hole in your pocket and let the money come out of it. Taking high interest personal loans for buying consumables is a very good example of Bad debt. More simply saying using high interest credit card, and transferring balance of on credit card into another, thus increasing the needless burden of debt. Another very good example could be buying more cars than required, for this most of the people go far car loans, eventually turning that debt into bad debt.

The thumb rule here is – any debt which is for such good, that will not help in wealth creation is a bad debt.

Managing Bad Debt

First thing one should do to manage Bad debt is to try not to increase it any more. I am saying this because to reduce anything, first thing to do is to stop the growth of that thing. For example, one should stop reducing Credit Card, because once you start paying cash for all the consumables, psychologically it start hitting one’s mind and reduces expenses. Once, growth of bad debt is curtailed, next step is to analyze current financial situation and start paying off bad debts., as they are not creating any wealth and depreciating one’s assets day by day. Another thing one should keep in mind is too much of any thing is not good and even too much of Good Debt can be harmful. The thumb rule for this what I think is that debt – earning ration for individuals should be 1:4 and one should not take any debt (even if that is good), if one doesn’t has any mean to pay it.

At the end of the day, the wealth creation is simply a function of increasing Good Debt vs. Bad Debt to the optimum point where the entire debt could be repaid my returns on the investment.

Remember!!! One is accountable for one’s debt and has to pay it by any means.

He that dies pays all debts.

William Shakespeare, "The Tempest", Act 3 scene 2

Creditors have better memories than debtors.

Benjamin Franklin, Poor Richard’s Almanac (1758)