“With great power comes great responsibility.” – Uncle Ben, character from Spider Man
While it’s completely possible to live debt-free, it’s not usually the smartest choice. No matter how “financially prepared” we think we are, life will always be uncertain. There will be a time when we need to take on debt. Very few people have the means to pay in cash for life’s most important purchases: a home, essentials, starting a business, or education. The most important consideration when taking on credit is whether the debt incurred is good or bad. To put it simply, debt is a sum of money that you owe someone. It could be to another person, loans from banks, or lending companies. There are two types of debt: good and bad.
We consider it good if it can generate money, or if it appreciates. However, debt is bad if it’s used for things that won’t give you any return or depreciates value. On a side note, good debt can quickly turn into bad debt. For today’s article, we will distinguish the difference between good and bad debts and how to go about it accordingly.
A simple way to identify good debts is: if it increases your net worth or has the potential to appreciate over time, it is good. Here are a few examples:
- Mortgages on Rental Property
One of the most important basic needs of a person is shelter. Renting out a property is a great investment because it follows the simple rule of good debts. It increases your net worth and its future value will increase over time. This is a big investment, so you must take its apprehensions and risks into account. Before giving ourselves the “go signal”, we must have proper financial advice and proper knowledge of the real estate industry.
2. Growing a Business
Utilizing debt can help boost your business. When planning to loan money to expand your business, first you must prove your business. Prove that you are providing a product or service that your clients want. Taking on debt to start a business is typically a risky idea since you never know how the business will go. Continue reinvesting to your business with your own cash until you reach the point when you can no longer grow without outside investment.
3. Student Loans
In the Philippines, most companies require a college degree if you’re applying from them. Many studies show that people with higher education have lower unemployment and make more money over the course of their lifetime. Of course, this is common sense. I’m not saying that college graduates always earn more than workers who don’t have degrees, but it’s fair to acknowledge that finishing college gives you the advantage to earn more money initially.
Now that we have discussed a few examples of good debts and its merits, it’s time for us to talk about its evil twin: Bad debts.
Bad debts are things you borrowed money for that won’t give you some sort of a return and will depreciate over time. Listed below are a few examples:
- Consumer Debt
According to Investopedia.com, consumer debt comprises personal debts that we owe as a result of purchasing goods that are used for individual or household consumption. This is by far the most common example of bad debt—many people suffer and live paycheck-to-paycheck to recompense the debt on things they bought impulsively. As Filipinos, we love to give pasalubong and gifts to our friends and family. While there’s nothing wrong with doing so, this admirable quality can also make Filipinos guilty of indulging others with things we can’t afford.
2. Car Loans
Brand new cars cost a lot of money to maintain and greatly decrease in value and depreciate quickly over time. Car loans also have high-interest loan rates. Such a high rate means that you’ll be allocating much of your monthly payment into interest. If you plan your expenditures carefully, you can buy your next car in cash.
3. Credit Cards
Credit cards can be a double-edged sword. We often associate credit card debt with consumer debt. The reason why we must avoid credit cards at all costs is that they encourage impulse purchases. If you only use cash and don’t have the cash to purchase something, you can’t buy it. This is not the case when you have a credit card in hand. When you make enough of those impulse purchases, bad credit card debt will follow.
Celebrations and gatherings are deeply embedded in Filipino culture. So much so that sometimes we get into debt just to finance parties. We buy new technology and lavish clothing to impress our colleagues and friends without realizing that more stuff won’t make us happy. Sure, maybe it can bring us short-term happiness, but it is never permanent. If I leave you with one message, I hope it’s this: Live within your means. When we live to impress others instead of living simply, debt can pile up quickly. I don’t want to imply that having credit is bad. Taking on debt is not an actual problem. The challenge is getting your finances under control.
If you want to start your journey to financial literacy, we will have future articles on simple steps on debt management, or you can consult a Registered Financial Consultant.
Disclaimer: Just a reminder, dear reader, that the content in this column is my opinion only and should not be construed as investment advice because I am not your financial adviser, neither did I take into consideration your personal objectives, financial situation, needs or circumstances as your fiduciary. This column is mainly for your entertainment and education only.