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Debt is money that one person or entity owes or is required to pay to another, generally as a result of a loan or other financial transaction. The outlook of debt according to the average person is quite bad. It is something you avoid as much as you can. A burden that shackles you and holds you back until you repay it in the future. While that is an accurate outlook, it is not the only one.
I first came across the concept of good debt and bad debt from Robert Kiyosaki, author of the classic Rich Dad Poor Dad book. In this post, we will be looking at both outlooks on debt and some examples.
Bad Debt
Traditionally, you must be credit worthy or provide collateral in order to get a loan. In most cases, you're asked what you're going to do with the loan. Once everything is approved, you're given the amount and a future date to pay it. Now, suppose Johnny bought a car with this loan and pays it by monthly installments from his salary. Johnny will be using this car for work and errands, it's now a daily part of his life.Can he afford the car? I doubt but it's making his life more comfortable, now he doesn't have to use public transport. Every month, a percentage of his earnings is taken to repay the debt and sometimes he also pays for car maintenance. Over time, the car keeps depreciating in value and he keeps repaying the debt. While he's 1/3 away from repaying the full debt, the car becomes near unusable and now have to spend more in maintenence.
That's bad debt in a nutshell, taking out loan to use for something that has no potential of appreciating in value over time or the ability to generate income for you. Other examples of bad debt is consumer tech like TVs, game consoles etc. That's why this Buy Now Pay Later (BNPL) model is catching speed, it encourages people to buy not so useful things they can't afford. Who wouldn't take it?
Good Debt
Good debt is just the opposite of bad debt. It's not always talked upon because of the commonality of bad debt. If you're scared of something you wouldn't want to know more about it. Yet, Good debt can be a great tool in your financial journey especially if you play your cards right. A favorite and classic example is taking a loan to buy a real estate property or a business. Let's say Sarah sees a 20 hecters of land for sale at $1 Million. She goes to the bank and takes out a loan of $200,000 as 20% down payment for the purchase. She thens splits the land into three pieces, a half and two quarters.After some months, She sold both quarters for $400,000 each. Now she has almost paid back the mortgage(Interest remains) and she still owns half of the land she bought! She can choose to do the same process with the remaining land or she can develop it for residential purposes. The property has the potential to increase in value over time and it can bring income for her. That's good debt.
This seems complex but it's just mathematics, a numbers game. But in this case, people won't border taking a loan since they can't afford it, they'll just pass on the opportunity. Why? Because it's complicated and people don't like complicated stuffs. We're naturally lazy so we just fall back and look for the easy way.
Summary
Able to differentiate good debt from bad debt is a good skill to have. Avoid bad debt, learn how to leaverage good debt to your advantage in your financial journey. Money is not the most important thing in life but it's one of them. That's just the world we live in, we're already in the game. Might as well play to win.But why are people comfortable with bad debt and uncomfortable with good debt?