NEW CONTRIBUTOR: "Is Debt Always Bad? Not Always."
Welcome to the first, of what I hope will be many, guest blog posts by individuals passionate about the stock market and supporters of educating all new investors. Nelly reached out to me on social media and expressed a strong interest to write for GradMoney. So without further adieu, please enjoy the following details on managing debt.
Good Nelly is a financial writer who has been associated with DebtCC Community for quite a long time. She loves to collect Financial data, and analyze/share among different communities in the form of articles. Other than DebtCC she also writes for other financial websites and blogs. Apart from writing, she loves to travel and gather ideas on food and nutrition, and taking new challenges.
D.E.B.T. - The word itself inculcates fear within us..but, it shouldn’t.
Debt is not bad; at least, not all debts are bad. In the present, we can’t live without obtaining some kind of loan, which is nothing but debt. Instead, what we must do is differentiate between good debt and bad debt.
Also, how we manage debt is important.
First of all, let’s differentiate a “good debt” from a “bad debt”.
Can a ‘debt’ be good? Yes.
Debt can be considered good when it can help you increase your net worth or helps you to generate a value.
Here are some examples of good debt:
Taking out a loan to start a business - You may not have the required capital to start a business. However, you’re confident that you’ll generate profit, and you can pay back the loan with ease.
It is better for a company to obtain debt to finance a portion of its business for 2 reasons:
Debt is cheaper than financing with equity. A company has no legal obligation to pay dividends to the common shareholders. They lose investments when a company goes bankrupt.
The interest on debt can be deducted from the corporate income tax. So, it is beneficial because the corporate tax rate is one of the highest among other taxes.
To pursue a college education - A person’s earning potential can be increased by pursuing a college education. With proper education, you can find a suitable job and can repay your education loan within the stipulated time.
Buying a house with a mortgage loan - When you take out a mortgage loan and start making the monthly payments, you start building equity on the property. Buying a property is making an investment for your future. Also, the mortgage interest is deductible on your income taxes, and the rate of interest is lower as compared to other debts, such as credit cards.
You can also borrow money to weatherize your house. By doing so, you’ll save a significant amount on your utility bills. So, if you calculate and compare, you may find that what you’re saving can offset the amount you borrowed.
Purchasing a vehicle with an auto loan - If you’re living in an area where public transportation isn’t available, you’ll have to buy a car. So, you can take out an auto loan to purchase the vehicle. However, an auto loan is not always considered to be a so-called good loan. But, you can make it a good debt by researching and obtaining the lowest possible rate. Also, take out a loan which you can afford so that you can make the monthly payments on time. To do so, you can automate your monthly loan payments so that you don’t miss out a payment date.
Now, let’s talk about bad debt.
Credit card debt - The one debt which tops the list of bad debt is credit card debt. If you have a habit of rolling your outstanding balance from one billing cycle to another, you’ve to pay interest on the unpaid amount. Moreover, the interest rate on credit cards is comparatively high. It’s also difficult to get out of credit card debt; so, it’s better to avoid it.
Borrowing from your retirement account - If you borrow money from your 401(k) account before 59½ years of age and can’t pay back the amount within 5 years, then you’ll have to pay early withdrawal penalty. Moreover, the interest you pay will also be taxed twice.
Buying clothes and taking out money for vacation - When you use your credit card to buy clothes or planning a holiday, you have to pay interest on it if you don’t repay the outstanding balance within that billing cycle. So, it’s better to buy clothes and other items with cash. This way, you can also purchase items which you can afford. However, it’s better to make the hotel bookings with a credit card; but, make sure you’re able to pay the outstanding amount within the due date.
Sometimes, a good debt can have a negative impact, too.
You have taken out too much secured debt
You have too much debt, and you’re about to retire in few years
You’ve taken out a variable interest rate loan and currently, the rate is higher
Your monthly debt payments are more than 36% of your gross monthly income
The ultimate goal is that you have to learn to manage your debts properly. Only by doing so, you can achieve financial success and have a secure financial future.