Sudipto Dasgupta is confused. He borrowed money from the bank for a home loan and also some more money as a personal loan to buy a home theatre system to enjoy the music that he loves. His financial advisor tells him that while a home loan is "good debt", acquiring a home theatre system worth Rs 1 lac is bad debt.
Certain types of debt can be used as financial tools to provide opportunities, such as a home loan or a student loan. To make smart decisions about if, when and how much to borrow, you need to understand how to manage debt and make it work for you.
Living beyond your means often results in the unfortunate consequence of falling into a debt trap. When you already don't have funds to pay back an existing loan, but you take a new personal loan to pay off an existing loan, you are putting yourself at a huge financial risk and into the vicious cycle of a debt trap. This could become a never-ending cycle for you when you are forever in debt because your income is never enough to pay off all your loans. You will forever be working not to enjoy the fruits of your income, but rather to repay your liabilities to the lender.
If building a good credit record is important to you, you need to know that the credit bureaus look and rate the different types of credit. They actually consider some credit accounts as being of less desirable and will lower your credit score if you rely heavily on them. Specifically, some instalment type accounts or loans, especially unsecured loans, may be viewed in a negative light.
Good debt v/s bad debt
Good debt is debt owed on an item that brings more value into your life than it takes in the form of money paid out. Good debt is temporary debt which ends with you having gained more than you invested. Debt taken on for what you think is a good reason isn't necessarily equal to good debt. For instance if you take a personal loan to pay off a hospital bill, it might have been an essential debt but would not qualify as good debt.
Bad debt occurs when you borrow to invest but the value of the investment drops over time. This means that the asset is non-income producing and interest on the loan is not tax-deductible, for instance credit card debt or personal loans. If you find yourself with a lot of bad debt, budget your way out. Remember, debt and credit cards are tools that if managed properly can work to your advantage.
About the author -
Rajiv Raj is a credit expert with 15 years of experience in personal finance and consumer banking industry and another 7 years in credit bureau sector. Rajiv was instrumental in setting up India's first credit bureau, Credit Information Bureau (India) Limited (CIBIL). He has also worked with Citibank, Canara Bank, HDFC Bank, IDBI Bank and Experian in various capacities. You can email Rajiv Raj at email@example.com.