We often hear much advice from our parents, and one of them is advice on staying out of debt.
Taking up a loan to make a big purchase seems to be a norm these days with the rise in inflation which made most of us asset rich but not cash-rich. But is it true that we should always pay up everything in full and stay away from debts?
Hmm.. What if I tell you there are actually good debts out there that we should actually consider taking?
What Is a Debt?
So what is debt? Before we start looking into the differences between good and bad debt, let us understand what exactly a debt is.
Debt, simply put, is borrowing money from another party, like taking up a loan. This party can be a bank, an organisation, a private company or even an individual like your family members or friends.
What’s a Good and Bad Debt ?
So… what exactly are good and bad debts, and are there any differences between them?
Surprise, Surprise! Debts can be different depending on these few points that we will be sharing today
1. Interest Rate
The first thing we can note is the interest rate that the provider is charging us.
Interest rates can differ depending on what the money is used for.
Let’s assume that the money is borrowed from the bank. Depending on the risk that the bank has to bear when borrowing out the money to you, the interest rate will be charged accordingly.
The higher the risk, the higher the interest rates. The risk that the bank is accessing can also depend on several factors such as your credit history, how stable are your flow of income/occupation and the purpose of borrowing the money.
2. Purpose of the Loan
Next, we need to understand the purpose behind the loan and being in debt.
Let’s say we are taking a loan for an appreciating asset like a property in Singapore. This can be considered good and healthy debt if the interest charged on the loan is lower than the rate of appreciation of the property price.
On the other hand, being in debt on a credit card loan that charges an exorbitant interest rate of 25%-30% just to make a purchase on depreciating branded clothing is considered an unhealthy debt.
3. Can You Support the Loan ?
After calculating the interest rates and finding a positive purpose to take on a loan, it is easy to decide on signing the papers before thinking twice.
BUT WAITT!!! Before we start treating this as money-making magic, we have to first consider whether we can actually support the loan. Everything, be it healthy or not should always be taken in moderation. Likewise for a healthy debt. So how much loan should we be taking?
We can’t possibly be servicing our debts with 100% of our income each month right ? We will still need to have other expenses elsewhere throughout the month. Hence, this is when financial planning could be helpful to get to understand our spending better before taking on a loan.
In Summary,
Taking up a good debt can be considered as taking up a loan that creates an opportunity that would more than repay itself – Something that appreciates in value.
On the other hand, bad debt can be considered as a loan taken on a liability that depreciates in value and also costs you more with the interest that is charged.
Should I Be In Debt ?
After getting to know more about debts, the good and the bad, we may wonder if we should actually start taking out loans and be in debt.
If you are like most Singaporeans, the first loan that you will be taking might be an education loan for university or a housing loan for a cosy house of yours. These can be considered healthy and good debts considering the opportunity cost an education could provide you with as well as a house that appreciates in value.
However, the next question then comes how much loan is considered healthy for me?
In our opinion, this will really depend from person to person as each of us have our own set of income, expenses, lifestyle as well as other financial goals and factors.
If you are considering taking up a loan anytime soon, why not chat with us to have us know you better and help you achieve your financial goals together?
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Learning about financial literacy can also be fun and easy! Stay with us in this financial journey one post at a time to find out how! If you haven’t already, you can check out our other work down below too, happy learning and reading!
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