Thursday, July 7, 2011

GOOD DEBT, BAD DEBT AND UGLY DEBT

"Neither a borrower, nor a lender be," cautions Shakespeare in Hamlet. The reality is, most of us carry debt. From a money management standpoint, that is not necessarily bad. Sometimes debt is good. Sometimes it's downright ugly. The key is to carry the right kind of debt, and not too much of it.

 

Good Debt

Good debt is generally debt that can provide a long-term financial payoff. An educational loan, either for your children or perhaps career education for yourself, is a good example. The improved earning power from the education should more than pay back the cost of the loan.
Mortgage/real estate debt is another "good" debt. To begin with, few consumers can afford to pay cash for a home. Also, a mortgage is good debt in the sense that a home is considered an investment, as most homes will appreciate in value over time.
Debt for business growth, expansion or working capital is also “good” debt especially for established businesses; the same cannot be said about financing a startup with debt.

 

Bad Debt

This tends to be short-term debt in which the loan lasts longer than the item you bought with the debt, and for which there is no financial payback. Most credit card debt falls into this category. People pay for everything from dinner to toys to clothing to vacations on their credit card and they're still paying for them long after the vacation is done or the toy is broken. Also, credit card debt tends to be very expensive-18 percent or more is common.
Loans for furniture, appliances, cars and other personal needs also can be fairly expensive, though usually not as high as credit cards. Save for these items, whenever possible, and pay for them in cash.

 

Ugly Debt

Some people would lump credit cards in this category especially in this part of the world. But I reserved this category for the really expensive debt that comes from what's commonly called "fringe banking." This includes "payday loans," interest on pawned household items and furniture (Shylocks). Interest rates for some of these loans can run 25 percent to 200 percent or more.

3 comments:

mathara munano said...

That's good information. Sad though, most people don't know how to spend money well. I think one should get a qualified financial adviser before borrowing any amount of money.

Foreign Investment Review Board said...

I think the biggest advantage is not having to feel responsible for someone else's financial decisions the way you might if you were a financial advisor and encouraging someone to make a particular choice.

Property Types Melbourne said...

I agree with you & the other commenters. There are a few circumstances when advice like that would make sense, but the fact that the article didn't go into those contingencies makes me deeply leery. I hope that the article means that they'll get some contrary advice, just so they have a chance to go into all of this with their eyes open! That financial planner should have his head examined.