Borrowing money is a common thing but before you borrow money, it’s very important to know the difference between good debt and bad debt. Somethings are worth going into debt, but many others can create a big financial mess for you. In this article we are going to discuss about good debt and bad debt.
What is a Good Debt?
In simple words a good debt is one which is a sensible investment for your future or the one which makes your financial status stronger even if it happens in long term. A good debt never has a negative impact on one’s overall financial position.
In general a good debt is the one for which we have a specific genuine reason to borrow the money whether it is from a bank or from a NBFC it doesn’t matter. For example taking a loan to purchase a home, a car which you can afford can be considered as a good debt. One of the reason to call it as a good debt is after few years of paying EMIs when you repay the whole amount you would have the ownership of that particular house or car. So, it is worth to go in a debt for these things.
Examples of Good Debts:
- Home Loan
- Car Loan
- Education Loan
- Mortgage Loan
- Business Loan
What is a Bad Debt?
A bad debt is one which is not a worth of its value and it drains your money as well. Bad debts can also be defined on the basis of ‘the loans which has no real prospect’ to go for. The interest rates are also high which results to high EMIs and hence difficult to afford.
Example of Bad Debts:
- Borrowing money to go for an unaffordable trip.
- Borrowing money for shopping or a lavish party.
- Loan for a purchasing expensive gadgets and equipment.
How to avoid a Bad Debt?
To prevent a loan from turning into a bad debt one should think and analyse these things even before applying for the loan:
- Is that loan for which you are going is really important to you? Are there no other options, except that loan?
- Have you compared for the interest rate for your loan with different lenders? If yes, is the interest rate offered by your lender same or lower than the other lenders proving the same loan.
- Would you be able to repay the loan amount easily without any trouble?
- Will you be able to pay the EMIs throughout the tenure period without upsetting your budget?
If the answer to any of the above mentioned question is NO then your debt is definitely a bad debt and you need to avoid it!
Understand and Analyse your Debt before you go for it!
Not all the loans are bad debt. Some debts are worth to go for as in the end you get the value in return for which you paid. If the loan which you are planning to avail, cannot be justified in terms of requirement, purpose, interest and repayments, such loans are always a bad loan. A very good example of a bad debt would be to take a loan of 4 year tenure for buying a flagship smartphone that would become outdated within 2-3 years of its launch. Nothing about this loan is justified, except that it is a wastage of money.
Even a personal loan of high interest rate for a medical purpose is justified as money can never be bigger than somebody’s life or health. And no one would mind bearing the burden of a personal loan in-exchange for the life or health of a dear one.
Use Equity Loans and Mortgage Loans
Whenever you need to borrow money always borrow from Equity Loans such as home Equity loan or from other Mortgage Loans. The reason behind advising you this is – the interest rates of these loans are low as compared to other loans and hence the EMIs are also low which makes these loan pocket friendly to you. Even the tenure period of these loans are long as compared to that of other loans.
What to do if You are already Trapped in Bad Debt
If you are already trapped in a bad debt and if it’s difficult to repay the loan or even you are facing difficulty in paying the EMIs there are few steps which you can take to get out of it-
- Go for Refinance or a Debt Consolidation Loan
If you have multiple loans on you and you find it difficult to repay the EMIs then you should go for a refinance. Refinance or debt consolidation is nothing but taking a new loan with low interest rate either from the same or even from different bank to pay off the outstanding amount of your previous loan. In this way you will end up with the high interest loan and you have to pay less EMI for your new loan.
- Talk to Your Lender
If you are not able to pay the EMI of any particular loan because you can’t afford that in that case you can talk to your lender. You can ask to your lender to reduce the EIMs and increase the tenure period. If you do so you will be able to repay the loan efficiently, this will cost you more as by increasing the tenure and reducing the EMI you will be paying more on the interest. But this is a better option against not paying the EMIs and continuously paying penalties as this affects your CIBIL Report and legal actions can also be taken against you.
- Ask Your Lender for Settlement
This is considered the best option when you are in a debt trap and are unable to repay. For this you need to talk to your lenders and make them agree for accepting an amount less than the total outstanding amount including principal and interest but more than the principal amount. If the bank agrees for this you can pay it off easily and get relaxed from this burden.
Bad Debts can lead to
Drainage of Your Money
A Bad Debt is the one whose interest rate is always high. Hence you have to pay a big amount from your monthly earning in EMI. This will slowly and gradually drain your money. Which is not at all worth.
In case if you are not able to repay the loan as it was a bad debt and had high interest value then in that case legal actions can be taken against you by the lender to recover the outstanding loan amount.
Ceasing of Collateral
In case if one is not able to repay the loan in the mentioned tenure period then the collateral which he/she has given against the loan will be ceased by the lender. Or the ownership of the collateral will go to the lender.
This is the last this which can happen to anyone in case of not repay a loan. In this all the money and property of the borrower will be taken over by the Bank. This only happens when the collateral is not given against the loan or when the value of the collateral offered is not of the same value as that of loan amount.